As a kid I enjoyed many TV shows, books and films. One of my favorite themes was espionage - James Bond in particular. Add a splash of science fiction and I would be hooked (e.g. The X-files) Often buried in the plot lines of intrigue, investigation, and government cover-up was a situation where some characters were only provided information on a “need-to-know” basis. I knew when I heard a line like “need-to-know” there was some mystery or jaw-dropping plot twist that I was likely to find out about. “Need-to-know” in this context implies secrecy or high security.
A different way of looking at “need-to-know” is to think about our “need-to-know” certain information in order to perform our job or even go about our daily lives. For instance I don’t need to know how an internal combustion engine works in order to drive my car. In our professional lives, albeit much less glamorous than 007, it seems to me that we all deal with some information that is “need-to-know”. It’s not likely to be the kind of information that’s particularly intriguing or sexy. It’s more likely to be data, terminology, or phrases that amount to specialized “shop-talk”. The details or specifics about certain policies and procedures are really only of interest to those whose job it is to “need-to-know” such things.
For me no where is this more evident than when I accompany my wife to a parent-teacher conference at my daughter’s school. My wife is also a teacher. It’s not uncommon for these “conferences” to dissolve into a discussion between just my wife and my daughter’s teacher that cover a dizzying array of teaching strategies, student-progress evaluation methods, and performance standards. It’s not necessarily complicated stuff, I just don’t “need-to-know” it. I just want to know if my daughter is doing ok in class or not.
Generally for most of us this type of thing is not a problem. It’s a sign that certain jobs and functions are compartmentalized and it often means that highly specific niches have developed. The downside is that things get much more complicated if specialized information like this must be communicated outside the originally intended group. This new group has it’s own set of biases and perspectives and may interpret the specialized information in a different way (or worse, incorrectly).
I can’t help but think about the stress-testing we do for our community bank clients and who “needs-to-know” the results. It used to be that it was only senior management and ALCO. Then it was also the examiners…then the Board. Sarbanes/Oxley (SOX) expanded the circle to include accountants and auditors. The FASB (and other groups) have added investors and shareholders to the mix. Finally the circle has expanded to include attorneys. I was recently asked by one of our publically traded clients to explain our IRR and Fair Value modeling processes to their attorneys. Imagine an attorney that looks like a deer in headlights as he’s desperately trying to grasp unfamiliar modeling terms like duration, discount rate construction, economic value of equity, rate shocks, rate ramps, and twists. (I have to admit it was childishly satisfying to render a lawyer speechless, if only for a minute.)
In October 2010 CSBS published a white paper entitled, “The Case for Stress Testing at Community Banks”. Towards the end of the document they address several issues related to widespread use of stress-testing. Here’s one in particular:
Should stress testing results be publically available?
Public disclosure was one of the elements of the SCAP program which proved successful. As Chairman Bernanke noted in his May 6, 2010 speech, public disclosure enhanced the credibility of the stress test. The disclosure provided transparency of the participating companies and the amount of capital required, if any. While the SCAP was very different in purpose and was conducted in an abnormal economic environment than any routine, general purpose stress test, an assessment must be made if and what type of data will be publicly available. While there is a legitimate case to be made that the results should be protected as supervisory information, there will be ongoing pressure to disclose results by analysts and market participants. There was a time when the bank’s call report and Uniform Bank Performance Report (UBPR) were considered confidential information.
Over the past year or so I’ve spent a considerable amount of time pondering this question. I’ve decided that my answer here is NO, stress-testing results should not be publically available, at least as far as community banks are concerned.
Seldom are there clear right or wrong “answers” produced through stress-testing. It’s not like an engineering stress-test where you find the breaking point of some material or structure. It’s more like a medical stress-test that tells you about the likelihood of a stroke or heart-attack, but there are no guarantees. However, the medical stress-test analogy can only take us so far. There is widespread agreement among medical professionals about what certain risk factors mean. This is only because there is a wealth of medical data available. Countless test results can be analyzed and correlated. Conclusions can be drawn and often times even verified.
We don’t have this wealth of stress-testing data for banks. And a large part of what we do have is based on subjective assumptions (take core deposit decay assumptions for example). The bank stress-testing that was performed as part of SCAP and the stress-testing we run for our community bank clients uses far fewer “scientific” facts than most people realize. There are many industry professionals who have a deep understanding of modeling, accounting, and analysis that believe the tools used for stress-testing are not ready for prime-time (see one example here, “SFAS 157, Fair Value and Other Fairy Tales” | Calculated Risk – 8/30/2008).
I generally agree that community banks can benefit from stress-testing. The process is not necessarily complicated but it can be extremely detailed and it involves making many assumptions. There is a real danger that the information will be “dumbed-down” and ultimately misinterpreted if made widely available. The general public still can’t make a meaningful distinction between a Wall Street bank and a community bank. Why should we believe that they’ll correctly (or meaningfully) interpret stress-testing results?
The circle of who “needs-to-know” the details and results of the stress-tests has expanded quite a bit. At this point though I don’t think the results are ready for public consumption and probably won’t be for some time to come.