Just days ago we reported that the Federal Reserve trumpeted the fact that all 33 participating banks passed the latest stress test. Banks also spent a lot of money on consultants in preparation for the stress tests as well.
After failing the Federal Reserve's annual stress tests in March 2014, the WSJ reports that Citigroup hired multiple consulting firms, and spent about $180 million on stress tests during the second half of 2014 in order to address regulator's concerns. It turns out that banks are spending tens of billions in order to prepare for stress tests, creating quite a lucrative business for consultants.
Globally, banks spent about $29 billion on consultants in 2015, much of that expense went for stress tests in the United States and elsewhere according to ALM Intelligence. The $29 billion is a 77% increase from the $16.35 billion that banks spent in 2007, growing significantly each year since the financial crisis. While banks continue to dramatically cut costs in other areas of the business, consulting fees is not an area that is taking a hit.
The industry has blossomed because if banks fail stress tests, the ability to raise dividends and buy back shares are limited – and how else can that EPS be maintained and lower revenue if shares can't be purchased? Accounting firms and consulting firms have all built specific practices around stress test consulting, and even BlackRock sold forecasting help to about two-thirds of the banks taking the tests. Not surprisingly, there are even consultants offering advice on how to use other stress-test consultants: "Kick out the consultants" Novantas advertised recently, telling banks it can help them cut back.
Stress tests require the banks to quantify precisely how much money would be lost under different scenarios, which is a difficult task for some banks with large global footprints. Being that banks generally under invested in the ability to perform such an analysis before the financial crisis, money is now being spent in order to catch up.
JPMorgan last year had about 550 people working solely on the Fed Stress tests, with more than 2,000 employees contributing indirectly the WSJ notes. "It's like a whole new department at the bank" said Joe Sullivan, president of International Market Recruiters, who helps banks fill stress-testing jobs.
The test submissions include a "narrative" document the size of a thick paperback, describing what the firm has done, accompanied by thousands of pages of documentation. Some banks employ professional writers to write the narratives so the Fed will have fewer questions later on. According to the WSJ, building a stress-test program can cost banks $150 million to $250 million a piece.
Financial firms globally will spend $4 billion on stress-test IT this year according to Chartist Research, which is up from $3 billion in 2014 and is expected to incresae 15% in 2017. Forecasting models alone generally range from $100,000 to $1 million depending on complexity – "We offer customized and off-the-shelf models to help you calculate the stressed probability of defaults" reads a 'Stress Testing Suites' brochure from Moody's Analytics.
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With all of this expense that banks are taking to prepare for stress tests, one would imagine that a slightly higher degree of focus would be put on the legal expenses that are being incurred – then again, those may just be "one-time" expenses that can be adjusted out of earnings in order to beat low analyst expectations each quarter, so perhaps the cost benefit isn't worth it… it's easier just to continue to fire people instead.
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