Commercial real estate stress testing in community banks: The low stress kind

Abstract

Stress testing has been identified as the most effective method currently available for analysing concentrations in banking portfolios. For community banks, stress testing does not need to be overly complex or involved. In today's constantly evolving regulatory environment, community banks must understand the increasing risk inherent in their lending portfolio. Whether commercial real estate (CRE) stress testing is performed on an internal basis or by a vendor it remains an important tool in evaluating risk. The process itself brings important benefits in structuring of loan data and quantifying the portfolio's risks. This article will present a framework for understanding and performing CRE stress testing in community banks that is gradative in practice and, in some respects, goes beyond the standards adopted by regulators.