Comptroller Dugan Calls 2009 Stress Tests a Great Success

CHARLOTTE, N.C.—Comptroller of the Currency John C. Dugan said today that last year’s stress tests, which were launched at a time of extraordinary economic uncertainty, played a crucial role in restoring market confidence in the nation’s large banks.

The tests, known formally as the Supervisory Capital Assessment Program (SCAP) proved to be “the most significant and successful policy proposal of the new Administration to address the banking crisis,” Mr. Dugan said in a speech before a symposium on credit markets sponsored by the Federal Reserve Bank of Richmond.

Today, he said, with 260 days remaining in the two-year period covered by SCAP, capital and reserves at large banks appear sufficiently strong to withstand the types of stresses tested in the program.

“The remarkable result is this: just one year after the nadir of public confidence in our financial system, the balance sheets of many large banks are in considerably better shape, and confidence has returned,” Mr. Dugan said. “SCAP demonstrated that a systematic, horizontal approach to stress testing can be practical and successful.”

Comptroller Dugan said economic conditions have proven to be far more benign than the environment described in the test’s adverse scenario, noting that realized losses for various types of credit have been much lower for the eight large national banks that participated in the tests than the adverse scenario projected. Moreover, pre-provision net revenues have been robust, and on an amortized, aggregate basis are running well ahead of the levels used for SCAP.

“Building a strong buffer in capital and reserves to absorb possible net losses that seem increasingly unlikely to occur, the SCAP banks have substantially fortified their balance sheets for the future,” Comptroller Dugan said.

However, Mr. Dugan warned against routine disclosure of supervisory stress tests, even though last year’s exercise was successful in large part because of disclosure.

“Routine disclosure of negative supervisory information – especially when that information is based on imperfect tests related to uncertain future events – could generate the type of confidence problems that it is our job as supervisors to prevent,” Mr. Dugan said.

In last year’s exercise, two factors weighed in favor of releasing results, he said. One was the critical need in the middle of the financial crisis to alleviate the exceptional degree of public uncertainty about banks’ financial condition. The other was the unique presence of a backstop of public capital – the TARP funds that were already at the disposal of Treasury – to fill any capital holes uncovered in the tests.

“Were it not for the existence of this ready source of capital, disclosing results for individual firms would have been very risky and very possibly counterproductive,” Mr. Dugan said.

The Comptroller said that SCAP showed the critical role played by examiners in both the design and implementation of the tests, and said the test results would be much less useful without examiner participation.

“It is my strong view that supervisory stress tests cannot be truly effective if they are purely analytical exercises executed at some distance from the firms being assessed,” Comptroller Dugan said. “As I have said, the largest banks are very complex institutions and at the OCC, we gain crucial insights into these banks through the daily, on-site presence of our teams of seasoned, professional examiners.”

Related Links

• Remarks before the Federal Reserve Bank of Richmond 2010 Credit Markets Symposium (PDF)
• Comptroller of the Currency John C. Dugan