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On March 28, the Federal Reserve Board released a report titled, “Dodd-Frank Act Stress Test 2019: Supervisory Stress Test Methodology,” which details the models and methodologies the Board will use for 2019 stress tests. The release is intended to “increase the transparency of [the Board’s] stress tests without compromising [its] ability to test the resiliency of the nation's largest banks.” Specifically, the report provides more information than in years past on the models that are used to project bank losses, including (i) ranges of loss rates for loans that are grouped by distinct risk characteristics; (ii) examples of portfolios with hypothetical loans with projected loss rates; and (iii) enhanced descriptions of models.
On March 6, the Federal Reserve Board (Fed) announced plans to limit the use of the “qualitative objection” in its Comprehensive Capital Analysis and Review (CCAR) exercise. Effective for the 2019 cycle, large U.S. bank holding companies and U.S. intermediate holding companies of foreign banking organizations that participate in four CCAR exercises and successfully pass the qualitative evaluation in the fourth year will no longer be subject to the evaluation under the final rule, which measures firms’ ability on a forward-looking basis to determine capital needs. Firms that fail to pass in the fourth year, the Fed noted, will continue to be subject to a possible qualitative objection until they pass. Moreover, all firms’ capital planning processes will still be evaluated, and firms will be required to pass the quantitative evaluation, which evaluates their ability to maintain minimum levels of capital under hypothetical stress scenarios. Furthermore, the Fed stated that it plans to no longer issue qualitative objections to any firms effective January 1, 2021, with the exception of firms who receive a qualitative objection the preceding year. Along with the final rule, the Fed released instructions for this year’s CCAR exercise, confirming that five of the 18 firms subject to this year’s CCAR exercises will possibly be subject to a qualitative objection.
On February 5, the Federal Reserve Board (Fed) released the scenarios banks and supervisors will use to conduct the 2019 Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act stress tests exercises for large bank holding companies and large U.S. operations of foreign firms. Each of the three scenarios—baseline, adverse, and severely adverse—include 28 variables that cover domestic and international economic activity. The Fed noted that “less-complex” firms with total consolidated assets between $100 billion and $250 billion have been moved to an extended stress test cycle for the 2019 cycle. (See related InfoBytes coverage here.) Capital plan and stress testing submissions are due by April 5.
In addition, the Fed finalized enhanced disclosures of the stress testing models used in annual CCARs beginning in 2019, which will be updated each year. The Fed also amended its policy regarding the economic scenario design framework for stress testing, and adopted a policy statement on prior disclosures, which outlines the Fed’s approach to model development, implementation, and validation. The changes are designed to increase the transparency of the stress testing exercises and provide significantly more information for firms.
FDIC, OCC issue notices of proposed rulemaking to raise asset threshold and reduce scope of stress testing requirements
On December 18, the FDIC issued a notice of proposed rulemaking (NPR) that would revise stress testing requirements for FDIC-supervised institutions, consistent with changes made by Section 401 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act). In particular, the proposed rule will (i) change the minimum threshold for applicability from $10 billion to $250 billion; (ii) revise the frequency of required stress tests for most FDIC-supervised institutions from annual to biannual; and (iii) reduce the number of required stress testing scenarios from three to two. Among other things, the FDIC proposes that, in general, FDIC-supervised institutions that are covered banks as of December 31, 2019, will “be required to conduct, report, and publish a stress test once every two years, beginning on January 1, 2020, and continuing every even-numbered year thereafter.” The proposed rule will also add a new defined term, “reporting year,” which will be the year in which a covered bank must conduct, report, and publish its stress test. However, the proposed rule notes that certain covered banks will still be required to conduct annual stress tests, such as covered banks that are subsidiaries of global systemically important bank holding companies or bank holding companies that have $700 billion or more in total assets or cross-jurisdictional activity of $75 billion or more, under rules proposed by the Federal Reserve Board. Furthermore, the proposed rule will remove the “adverse” scenario—which the FDIC states has provided “limited incremental information”—and require stress tests to be conducted under the “baseline” and “severely adverse” stress testing scenarios.
Separately the same day, the OCC also issued a NPR to amend the agency’s stress testing rule for covered financial institutions to be consistent with Section 401, which incorporates the revisions described in the FDIC’s NPR.
Comments on both NPRs are due by February 19, 2019.
On October 31, the OCC published in the Federal Register proposed changes to its “stress test” rules for covered financial institutions, as required by the Dodd-Frank Act. The proposal would, among other things, (i) revise the OCC reporting requirements to mirror the Federal Reserve Board’s proposed Comprehensive Capital Analysis and Review (CCAR) reporting form FR Y-14A for covered institutions with total consolidated assets of $100 billion or more; (ii) implement the revised asset threshold mandated by the Economic Growth, Regulatory Relief, and Consumer Protection Act; and (iii) remove the Retail Repurchase worksheet. Comments on the proposed changes must be received by December 31.
On October 31, the Federal Reserve announced a proposed rulemaking to more closely match certain regulations for large banking organization with their risk profile. The proposal would establish four risk-based categories for applying the regulatory capital rule, the liquidity coverage ratio rule, and the proposed net stable funding ratio rule for banks with $100 billion or more in assets. Specifically, the Federal Reserve proposes to establish the four categories using risk-based indicators, such as size, cross-jurisdictional activity, weighted short-term wholesale funding, nonbank assets, and off-balance sheet exposure. According to the proposal, the most significant changes will be for banks are in the two lowest risk categories:
- Banks with $100 billion to $250 billion in total consolidated assets would generally fall into the lowest risk category and would (i) no longer be subject to the standardized liquidity requirements; (ii) no longer be required to conduct company-run stress tests, and (iii) be subject to supervised stress tests on a two-year cycle.
- Banks with $250 billion or more in total consolidated assets, or material levels of other risk factors, that are not global systemically important banking institutions (GSIBs), would (i) have reduced liquidity requirements; and (ii) only be required to perform company run stress tests on a two-year cycle. These banks would still be subject to annual supervised stress tests.
Banks in the highest two risk categories, including GSIBs, would not see any changes to capital or liquidity requirements. A chart of the proposed requirements for each risk category is available here.
Comments on the proposal must be received by January 22, 2019.
Additionally, the Federal Reserve released a joint proposal with the OCC and FDIC that would tailor requirements under the regulatory capital rule, the Liquidity Coverage Ratio and the proposed Net Stable Funding Ratio to be consistent with the prudential standard changes.
Federal Reserve requests comments on proposal to include omitted items from capital assessments and stress testing information collection
On August 8, the Federal Reserve Board published a notice and request for comment in the Federal Register seeking to revise, without extension, the existing information collection “Capital Assessments and Stress Testing.” The information collection is applicable to bank holding companies with total consolidated assets of $100 billion or more and U.S. intermediate holding companies established by foreign banking organizations that are subject to enhanced testing in order to mitigate risks to the financial stability of the United States. Last December, the Fed published modifications to the FR Y-14Q, Schedule L, which took effect as of the March 31, 2018, report date. However, following the adoption of the proposed changes, the Fed became aware of items mistakenly omitted from the report forms and instructions for the FR Y-14Q, which require respondents to report “total stressed net current exposure under the two supervisory stressed scenarios.” The proposal will revise sub-schedule L.5 (Derivatives and SFT Profile) for the FR Y-14Q report by adding the missing items. Comments on the proposal must be received by October 9.
On August 7, the Federal Housing Finance Agency (FHFA) published a report providing the results of the fifth annual stress tests conducted by government-sponsored enterprises Fannie Mae and Freddie Mac (GSEs). According to the report, Dodd-Frank Act Stress Tests Results – Severely Adverse Scenario—which provides modeled projections on possible ranges of future financial results and does not define the entirety of possible outcomes—the GSEs will need to draw between $42.1 billion and $77.6 billion in incremental Treasury aid under a “severely adverse” economic crisis, depending on how deferred tax assets are treated. The losses would leave $176.5 billion to $212 billion available to the companies under their current funding commitment agreements. Notably, the projected bailout maximum is lower this year than FHFA reported last year, which ranged between $34.8 billion and $99.6 billion.
Federal Reserve vice chairman discusses tailoring prudential standards to account for complexity and risk
On July 18, Federal Reserve Vice Chairman for Supervision Randal K. Quarles spoke before the American Bankers Association’s conference in Salt Lake City to discuss ways the Fed can tailor the supervision and regulation of prudential standards for financial institutions with assets between $100 billion to $250 billion. According to Quarles, U.S. regulators should consider scaling back resolution plan requirements and tailor regulation to risk. In discussing resolution plans, also known as living wills, Quarles noted, among other things, that the Fed “should consider limiting the scope of application of resolution planning requirements to only the largest, most complex, and most interconnected banking firms because their failure poses the greatest spillover risks to the broader economy.” Furthermore, banks that do not qualify as global systemically important banks (G-SIBs) should also be granted some measure of regulatory relief, Quarles stated. Existing G-SIB tests and surcharge indicators could be used for measuring cross-border activity, short-term wholesale funding, as well as nonbank activities while the Fed determines adjustments for less complex banks between the $100 billion and $250 billion range. “This review should ensure that our regulations continue to appropriately increase in stringency as the risk profiles of firms increase, consistent with our previously stated tailoring goals and the new legislation,” Quarles said. “The supervision and regulatory framework for these firms should reflect that there are material differences between those firms that qualify as U.S. G-SIBs and those that do not.” Moreover, according to Quarles, while the Economic Growth, Regulatory Relief, and Consumer Protection Act mandates an 18-month deadline for regulators to issue proposed changes, the Fed plans to “move much more rapidly than this.”
Federal Reserve chair delivers semi-annual congressional testimony, discusses U.S. financial conditions and regulatory relief act
On July 17, Federal Reserve Chair Jerome Powell testified before the Senate Banking Committee and spoke the next day before the House Financial Services Committee. In his semi-annual congressional testimony, Powell presented the Federal Reserve’s Monetary Policy Report, and discussed the current economic situation, job market, inflation levels, and the federal funds rate. Powell stressed, among other things, that interest rates and financial conditions remain favorable to growth and that the financial system remains in a good position to meet household and business credit needs. Chairman of the Committee, Senator Mike Crapo, R-Idaho, remarked in his opening statement that, while recent economic developments are encouraging, an effort should be made to focus on reviewing, improving, and tailoring regulations to be consistent with the recently passed Economic Growth, Regulatory Relief, and Consumer Protection Act S.2155/P.L. 115-174 (the Act). During the hearing, Powell confirmed that the Fed plans to implement provisions of the Act as soon as possible. (See previous InfoBytes coverage here.) When questioned by Senator Sherrod Brown, D-Ohio, about the direction the Fed plans to take to address stress test concerns, Powell responded that the Fed is committed to using stress tests, particularly for the largest, most systemically important institutions, and that going forward, the Fed wants to strengthen the tests and make the process more transparent. Powell also indicated the Fed intends to “publish for public comment the range of factors [the Fed] can consider” when applying prudential standards. Powell also stated that he believes government-sponsored-enterprise reform would help the economy in the long term.
When giving testimony to the House Financial Services Committee, Powell also commented that cryptocurrency does not currently impair the Fed’s work on monetary policy and that the Fed will not seek jurisdiction over cryptocurrency and instead will defer to the SEC’s oversight as well as Treasury’s lead to identify the right regulatory structure.
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