Missed Opportunity on Stress Tests?

When the Federal Reserve Bank ("FRB" or "Fed") conducted stress tests of the 19 largest financial institutions back in 2009, many viewed it primarily as an exercise to restore the public's faith in the financial system. Now that the FRB has requested the financial institutions to perform the same tests again, some are wondering if the tests should be redesigned to be more realistic.  One of those raising questions is Sim Segal, an ERM expert who wrote an article on the subject this week in Forbes magazine. Here's his view:

....to be meaningful, the Fed stress tests must be changed to include (1) multiple simultaneous risks events, to capture the biggest potential threats, (2) all sources of risk, particularly strategic and operational ones, which represent the bulk of risks, (3) a full quantification of risk exposures, measuring the impact on value rather than on capital, (4) examination of the largest companies in all sectors that can threaten the economy, not just banks, and (5) worst-case scenarios provided by company insiders, to test each firm's most vulnerable spots.

Mr. Segal raises some very good points that should be considered by not only the FRB and the Financial Stability Oversight Council, but also the individual financial institutions.  For those financial institutions and other companies that are not performing stress tests in the manner suggested by Mr. Segal, it could represent a missed opportunity that could prove fatal.