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Federal Reserve Board Finalizes Enhanced Prudential Standards For Large Bank Holding Companies, Foreign Banks
On February 18, the Federal Reserve Board issued a final rule that incorporates elements of two previously proposed rules related to U.S. bank holding companies with assets of $50 billion or more and foreign banking organization with assets of $50 billion or more. For covered domestic bank holding companies, the final rule (i) incorporates as an enhanced prudential standard previously-issued capital planning and stress testing requirements; and (ii) imposes enhanced risk-management, including liquidity risk-management standards. The rule further imposes a 15-1 debt-to-equity limit for companies that pose a grave threat to U.S. financial stability, as determined by the FSOC. For covered foreign banking organizations, the rule (i) implements enhanced risk-based and leverage capital requirements, liquidity requirements, risk-management requirements, stress testing requirements, and the debt-to-equity limit for FSOC-designated companies; and (ii) requires foreign banking organizations with U.S. non-branch assets of $50 billion or more to form a U.S. intermediate holding company (IHC) and imposes the same enhanced requirements on the IHC. The rule also establishes enterprise-wide risk-committee requirements for publicly traded domestic bank holding companies with total consolidated assets of $10 billion or more and for publicly traded foreign banking organizations with total consolidated assets of $10 billion or more, and implements stress-testing requirements for foreign banking organizations and foreign savings and loan holding companies with total consolidated assets of more than $10 billion. The final rule does not apply to non-bank financial firms designated as systemically important by the FSOC. The rule takes effect on June 1, 2014, but covered U.S. bank holding companies have until January 1, 2015 to comply. Foreign banking organizations must submit an implementation plan by January 1, 2015, but have until July 1, 2016 to comply. The final rule generally defers application of the leverage ratio to IHCs until 2018.
Prudential Regulators Release Stress Test Scenarios
On November 12, the FDIC released the economic scenarios that will be used by certain financial institutions with total consolidated assets of more than $10 billion for stress tests required under the Dodd-Frank Act. Each scenario includes key variables that reflect economic activity, including unemployment, exchange rates, prices, income, interest rates, and other salient aspects of the economy and financial markets. The baseline scenario represents expectations of private sector economic forecasters; the adverse and severely adverse are hypothetical scenarios designed to assess the strength and resilience of financial institutions and their ability to continue to meet the credit needs of households and businesses under stressed economic conditions. The FDIC release follows the recent release of stress test scenarios by the Federal Reserve Board and the OCC. The Federal Reserve Board also recently issued a final policy statement that describes the process by which it will develop future stress test scenarios.
Federal Reserve Board Issues Rules on Incorporating Basel III Into Stress Tests
On September 24, the Federal Reserve Board issued two interim final rules that clarify how companies should incorporate the Basel III regulatory capital reforms into their capital and business projections during the next cycle of capital plan submissions and stress tests. The first interim final rule clarifies that in the next capital planning and stress testing cycle, bank holding companies with $50 billion or more in total consolidated assets must incorporate the revised capital framework into their capital planning projections and into the stress tests using the transition paths established in the Basel III final rule. This rule also clarifies that for the upcoming cycle, capital adequacy at these companies will continue to be assessed against a minimum 5% tier 1 common ratio calculated in the same manner as under previous stress tests and capital plan submissions. For most banking organizations with between $10 billion and $50 billion in total consolidated assets, the second interim final rule provides a one-year transition period. During their first stress test cycle (scheduled to begin October 1), these companies will be required to calculate their projections using the current regulatory capital rules in order to allow time to adjust their internal systems to the revised capital framework. Both rules clarify that covered companies will not be required to use the advanced approaches in the Basel III capital rules to calculate their projected risk-weighted assets in a given capital planning and stress testing cycle unless the companies have been notified by September 30 of that year.
Federal Reserve Board Paper Reviews Large Bank Capital Planning
On August 19, the Federal Reserve Board released a paper that details its expectations for internal capital planning at large bank holding companies and describes the range of practices the Board has observed during the stress test exercises conducted to date. The Federal Reserve conducts the stress tests annually to assess companies’ capital planning processes and ensure that the processes account for unique risks and result in sufficient capital to enable the institutions to continue lending to households and businesses during times of economic and financial stress. The Board stated that the paper is intended to promote better capital planning at bank holding companies generally, and to provide greater clarity on the standards against which those practices are evaluated as part of the stress test exercise. The Board found that firms needed to improve a number of aspects of their capital planning processes, including their accounting for risks most relevant to the specific business activities, their methods of projecting the effect of certain stresses on their capital needs, and their governance of the capital planning processes, and emphasized that bank holding companies, when considering their capital needs, should focus on the specific risks they could face under potentially stressful conditions.
OCC Updates Handbook to Reflect Current CRE Lending Guidance
On August 20, the OCC issued bulletin OCC 2013-19, which attaches the Commercial Real Estate Lending booklet of the Comptroller’s Handbook to replace the OCC’s Commercial Real Estate and Construction Lending booklet. The new booklet reflects guidance issued since the prior booklet was released in 1995. That updated guidance relates to prudent loan workouts, management of concentrations, stress testing, updated interagency appraisal guidelines, and statutory and regulatory developments in environmental risk management. The booklet also incorporates discussions of statutes and regulations governing federal savings associations.
Prudential Regulators Propose Stress Test Guidance for Mid-Size Institutions
On July 30, the OCC, the FDIC, and the Federal Reserve Board proposed guidance for stress tests conducted by institutions with more than $10 billion but less than $50 billion in total consolidated assets. Under Dodd-Frank Act mandated regulations adopted by the regulators last October, such firms are required to conduct annual company-run stress tests starting in October 2013. The guidance discusses supervisory expectations for stress test practices, provides examples of practices that would be consistent with those expectations, and offers additional details about stress test methodologies. It also underscores the importance of stress testing as an ongoing risk management practice that supports a company’s forward-looking assessment of its risks and better equips the company to address a range of macroeconomic and financial outcomes. Comments on the proposed guidance are due by September 25, 2013.
Banking Agencies Update Leveraged Lending Guidance
On March 21, the Federal Reserve Board, the OCC, and the FDIC issued final interagency guidance to ensure institutions provide leverage lending in a safe and sound manner by: (i) identifying the institution's risk appetite for leveraged finance, establishing appropriate credit limits, and ensuring prudent oversight and approval processes; (ii) establishing underwriting standards that clearly define expectations for cash flow capacity, amortization, covenant protection, collateral controls, and the underlying business premise for each transaction, and consider whether the borrower’s capital structure is sustainable; (iii) concentrating valuation standards on the importance of sound methods in the determination and periodic revalidation of enterprise value; (iv) accurately measuring exposure on a timely basis, establish policies and procedures that address failed transactions and general market disruptions, and ensure periodic stress tests of exposures to loans not yet distributed to buyers; (v) developing information systems that accurately capture key obligor characteristics and aggregate them across business lines and legal entities on a timely basis, with periodic reporting to the institution’s board of directors; (vi) considering in risk rating standards the use of realistic repayment assumptions to determine a borrower’s ability to de-lever to a sustainable level within a reasonable period of time; (vii) establishing underwriting and monitoring standards similar to loans underwritten internally; and (viii) performing stress testing on leveraged loans held in portfolio as well as those planned for distribution. The new guidance took effect on March 22, 2013, and institutions have until May 21, 2013 to comply.
OCC Requests Comment on Annual Stress Test Reporting
On March 15, the OCC requested comment on its new regulatory reporting requirement for national banks and federal savings associations, which the OCC adopted in an October 2012 final rule. The notice and request for information describes the proposed scope of the reporting and the proposed reporting requirements for covered institutions with consolidated assets between $10 and $50 billion. The OCC also released copies of the reporting templates and instructions referenced in the notice. Comments on the notice are due by May 10, 2013.
Federal Reserve Board Releases Stress Test Results
On March 7, the Federal Reserve Board (FRB) released summary results of stress tests conducted for the 18 largest banks. This is the third round of stress tests conducted by the FRB, but the first conducted under new Dodd-Frank Act stress test requirements. According to the FRB, under the severe, nine-quarter hypothetical scenario, projected losses at the 18 bank holding companies would total $462 billion, and the aggregate tier 1 common capital ratio would fall from an actual 11.1 percent in the third quarter of 2012 to 7.7 percent in the fourth quarter of 2014. The FRB assures that despite the large hypothetical declines, the aggregate post-stress capital ratio exceeds the actual aggregate tier 1 common ratio of approximately 5.6 percent prior to the government stress tests conducted in the midst of the financial crisis.
Federal Reserve Board Proposes New Oversight of Foreign Banks
On December 14, the Federal Reserve Board (FRB) announced a proposal to strengthen its capabilities to oversee certain foreign banks that operate in the U.S. and move from the SEC to the Federal Reserve oversight of foreign bank broker-dealers. The proposal is aimed at fixing problems arising out of the financial crisis, specifically the way in which the SEC has regulated broker-dealer net capital over the past decade. Many blame the SEC’s 2004 decision to lower net capital requirements as exacerbating the economic downturn. Before the change, broker-dealers were permitted to maintain debt to equity ratios of approximately 12 to 1. After the SEC’s 2004 change, broker-dealers were permitted to dramatically reduce their net capital obligations resulting in debt to equity ratios of 30 or 40 to 1. The proposed rules generally apply to foreign banking organizations with a U.S. banking presence and total global consolidated assets of $50 billion or more and would subject certain U.S. operations of such firms to capital plan stress tests, single-counterparty credit limits, overall risk management, and early remediation. In addition, a foreign banking organization with both $50 billion or more in global consolidated assets and U.S. subsidiaries with $10 billion or more in total assets generally would be required to organize its U.S. subsidiaries under a single U.S. intermediate holding company (IHC) to allow for the consistent supervision and regulation of the U.S. operations of foreign banking organizations and help facilitate the resolution of failing U.S. operations of a foreign bank if needed. As proposed, the rules also would subject IHCs to the same risk-based and leverage capital standards applicable to U.S. bank holding companies. Further, IHCs with $50 billion or more in consolidated assets would be subject to the capital plan rule. Finally, the U.S. operations of any foreign banking organization with combined U.S. assets of $50 billion or more would be subject to certain enhanced liquidity requirements. The FRB plans to give covered foreign firms until July 1, 2015 to comply. Comments on the proposal are due by March 31, 2013.