Planning for an economic downturn is key to sustaining independence

Karen Grandstrand

Banks are enjoying good times and, as one regulator recently told me, “peace time” in terms of regulatory findings and enforcement actions. Hopefully this peace time will continue. However, in case it does not last, it is wise to consider steps that can be taken now to avoid (or at least mitigate) financial stress, which could lead to the need to sell your institution or take on partners. Here are nine areas where I encourage you to focus:


Stress Testing. The Dodd-Frank Act requires all insured depository institutions with $10 billion or more in total consolidated assets to conduct and report to their primary federal bank regulators annual company-run stress tests (DFAST stress testing). The Economic Growth, Regulatory Relief, and Consumer Protection Act (Economic Growth Act) that was signed into law by President Trump on May 24, 2018 raised the asset threshold for required DFAST stress testing for all financial institutions from $10 billion to $100 billion, and made the requirement “periodic” rather than annual. 

Thus, while government-mandated stress testing has been relaxed, there is a level of stress testing that banks may nevertheless want to continue to perform in order to determine how a downturn would potentially affect capital and earnings.

Concentration. Last fall, the federal banking agencies issued an Interagency Statement Clarifying the Role of Supervisory Guidance. The statement explained that, unlike a law or regulation, supervisory guidance does not have the force and effect of law and the agencies do not take enforcement actions based on supervisory guidance. Rather, supervisory guidance outlines supervisory expectations and the agencies’ general views. 

Further, examiners may identify unsafe or unsound practices or other deficiencies in risk management during an examination and reference supervisory guidance to provide examples of safe and sound conduct. While the agencies may no longer cite banks for violations of guidance, I believe the CRE concentration guidelines will continue to be an important benchmark when regulators assess the safety and soundness of bank portfolios (and management and board action) in any downturn. I would take those benchmarks seriously and monitor CRE and other concentrations. Diversification can help mitigate financial stress and, accordingly, if you have a concentrated portfolio, know what those risks are and consider ways to mitigate them.

Liquidity. A liquidity crisis can cause an overnight failure; a capital crisis is, by contrast, a slow death. Therefore, focus on ways to grow those core deposits and have a back-up plan. In addition, do not forget to assess the liquidity needs of your holding company. If your holding company’s only source of cash is dividends from the subsidiary bank, this is a risk. If the bank encounters financial stress, either the bank regulator, the Federal Reserve, or both, will not allow the holding company to obtain dividends from the bank.

Capital cushion. The best time to raise capital is when you do not need it. Is now the time?

Balance sheet clean-up. Right before the last recession, a few of my clients sold off their mortgage portfolios when the portfolios were just beginning to show some financial stress. The banks were able to sell the assets before discounts were such that they could not afford the size of the hit to capital. Balance sheet management probably saved one or more of those banks.

An expense control plan. Another what-if you may want to consider relates to expense control. Consider what costs are needed for survival: What are discretionary and what are needed for strategic objectives? Also, evaluate whether you should replace some fixed costs with variable costs. Developing a plan now when you have time to thoroughly consider various factors (because you are not in survival mode) will enable you to act quickly to implement a cost management plan if needed.

Identify loan workout resources and training needs. It has been a long time since most banks had to be staffed and prepared to do significant loan workouts. Start planning — this might be a good time to add that to your staff training program.

Insurance. Reassess your insurance coverage in terms of bond, D&O, and cyber. Pricing and exclusions (and the carriers) have changed significantly since the financial crisis.

Build your board. Within the past few weeks several of my clients have contacted me to discuss board composition. This led me to start thinking about when the best time is to build a board. It is always difficult to identify and attract excellent board members; however, doing this in times of financial stress is even more difficult. Therefore, similar to my comment on capital cushion, now may be a good time to reassess and enhance the composition of your board.

I remain hopeful we can all enjoy peace time a bit longer. But economic downturns, like taxes (and death), are certainties. Therefore, now is the time for thoughtful preparation and planning.


Author Bio: Karen Grandstrand is a nationally recognized M&A and financial services regulatory attorney and a financial industry advisor. She is a shareholder in the Minneapolis law firm of Fredrikson & Byron, P.A., and chair of the firm’s Bank and Finance Group. Prior to joining Fredrikson, she had a 14-year career with the Federal Reserve Bank of Minneapolis where she was the senior vice president of the Banking Supervision and Risk Management Departments. Contact her at [email protected] or 612-492-7153.