Man plans, God laughs, according to the Yiddish proverb. Bank regulators, not so much—at least not when it comes to risk management, which continues to be an ever-moving target for financial institutions. Providing stakeholders with assurance that the risk control frameworks financial institutions have adopted will hold fast in an actual emergency is an ongoing challenge, and banks test their plans annually. The tests are meant to be aggressive and realistic—in a regulatory vernacular, they need to represent an “effective challenge.” Getting effective challenge right, however, is easier said than done.
This article explains guidance recently published by the Federal Reserve and the OCC outlining the characteristics of an effective challenge.