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Fed releases final capital requirements for all large banks
On August 28, the Fed released its final capital requirements for large bank holding companies. As previously covered by InfoBytes, the Fed derived these requirements from stress test results showing that large banks had “sufficient capital” to absorb losses and withstand a recession. Each large bank’s total common equity tier 1 (CET1) capital must include:
- A minimum CET1 capital ratio of 4.5 percent;
- A stress capital buffer requirement of at least 2.5 percent, which was determined, in part, on the results of the supervisory stress test; and
- A 1.0 percent capital surcharge for each bank deemed a global systemically important bank (G-SIB).
A table on the final page displayed all banks’ requirements. The requirements will take effect on October 1.
Fed’s 2024 stress test results show a robust banking system
Recently, the Fed released the 2024 Federal Reserve Stress Test Results and found that the tested banks have “sufficient capital” to absorb losses and weather a recession while staying above minimum capital requirements. The Fed tested 31 large banks this year and found those banks have enough capital to absorb a projected $685 billion in losses and remain above their minimum capital requirements. While the Fed found a 2.8 percent decline in the aggregate capital ratio (greater than last year’s decline of 2.5 percent), the decline was within the range of recent stress tests. The Fed attributed this 2024 change to three factors:
- The Fed projected greater credit card losses due to a substantial increase in banks’ credit card balances, along with higher delinquency rates. In the stress test, banks were projected to lose $175 billion on credit cards, which was 17.6 percent of credit card balances.
- The Fed projected higher corporate losses due to banks having riskier corporate credit portfolios.
- The Fed projected a decline in net revenue. The Fed found that noninterest expenses (compensation, real estate, etc.) continued to increase, while noninterest income sources (e.g., investment banking fees) declined significantly.
Despite these factors, the Fed concluded that large banks could still lend to households and businesses while remaining “well above” minimum capital requirements.
Fed’s Bowman speaks on bank liquidity a year after banking crises
On April 3, Fed member Michelle Bowman delivered a speech on “Bank Liquidity, Regulation, and the Fed’s Role as Lender of Last Resort.” Her speech highlighted three points: first, she discussed how the Fed supported liquidity in the banking system; second, she discussed the broader framework that supported bank liquidity, including regulatory requirements, bank supervision, and deposit insurance; and third, she discussed the challenges the Fed faced in implementing liquidity tools. On the Fed’s role in banking system liquidity, Bowman mentioned how the banking system was stronger today than before the 2008 financial crisis due to having more capital and more liquidity, as well as new stress testing requirements. The Fed’s emergency lending authority also changed to be broad-based, as opposed to having designed it for individual companies, and now required approval by the Secretary of the Treasury. On challenges, Bowman highlighted how to reduce the stigma associated with discount window borrowing by mandating that banks “pre-position collateral” and “periodically borrow from the discount window.”
Fed, FDIC, and OCC release stress test scenarios for 2024
On February 15, the Fed, OCC, and the FDIC released their annual stress test scenarios for 2024 to assist the agencies in evaluating their respective covered institution’s risk profile and capital adequacy. The Fed released its “2024 Stress Test Scenarios” to be used by banks and supervisors for the 2024 annual stress test. The scenarios include hypothetical sets of conditions to evaluate the banks under baseline and severely adverse scenarios. The OCC similarly released economic and financial market scenarios to be used by national banks and federal savings associations and include both baseline and severely adverse scenarios as mandated by the stress testing requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The FDIC also released its stress test scenarios for certain state nonmember banks and state savings associations in conjunction with the OCC and the Fed.
EBA report recommends environmental and social risk enhancements for financial sector
On October 12, the European Banking Authority (EBA) announced the publication of a report on the role of environmental and social risks in the prudential framework of credit institutions and investment firms. The report recommends risk-based enhancements to the risk categories of the Pillar 1 framework, which sets capital requirements, noting that environmental and social risks are “changing the risk picture for the financial sector” and are expected to be more prominent over time. The report puts forward recommendations for actions over the next three years as part of the revised capital requirements regulations. Specifically, the EBA is proposing to: (i) include environmental risks as part of stress testing programs; (ii) encourage the inclusion of environmental and social factors as part of external credit assessments by credit rating agencies; (iii) encourage the inclusion of environmental and social factors as part of due diligence requirements and valuation of immovable property collateral; (iv) require institutions to identify whether environmental and social factors constitute triggers of operational risk losses; and (v) develop environment-related concentration risk metrics as part of supervisory reporting. With respect to revisions to the Pillar 1 framework, the report proposes: (i) the possible use of scenario analysis to enhance the forward-looking elements of the prudential framework; (ii) changes to the role that transition plans could play in the future; (iii) reassessing the appropriateness of revising the internal ratings-based supervisory formula and the corresponding standardized approach for credit risk to better reflect environmental risk elements; and (iv) the introduction of environment-related concentration risk metrics under the Pillar 1 framework.
Fannie Mae, Freddie Mac annual stress tests results
On August 10, FHFA published the Dodd-Frank Act Stress Tests Results – Severely Adverse Scenario containing the results of the ninth annual stress tests conducted by Fannie Mae and Freddie Mac (GSEs) as required by the Dodd-Frank Act. Last year, FHFA published orders for the GSEs to conduct a stress test with specific scenarios to determine whether companies have the capital necessary to absorb losses as a result of severely adverse economic conditions (covered by InfoBytes here). According to the report, the total comprehensive income loss is between $8.4 billion and $9.9 billion depending on how deferred tax assets are treated. Notably, compared to last year, the severely adverse scenario includes a larger increase in the unemployment rate due to the lower unemployment rate at the beginning of the planning horizon. FHFA also expanded the scope of entities considered within the primary counterparty default component of the worldwide market shock. This expansion encompasses mortgage insurers, unsecured overnight deposits, providers of multifamily credit enhancements, nonbank servicers, and credit risk transfer reinsurance counterparties.
Agencies release hypothetical scenarios for 2023 bank stress tests
On February 9, the Federal Reserve Board and the OCC released hypothetical economic scenarios for use in the upcoming stress tests for covered institutions. The Fed released supervisory scenarios, which include baseline and severely adverse scenarios. According to the Fed, the stress test evaluates large banks’ resiliency by estimating losses, net revenue, and capital levels under hypothetical recession scenarios that extend two years into the future. The Fed’s stress test also features for the first time “an additional exploratory market shock to the trading books of the largest and most complex banks” to help the agency better assess the potential of multiple scenarios in order to capture a wider array of risks in future stress test exercises. The OCC also released the agency’s scenarios for covered banks and savings associations, which will be used during supervision and will assist in the assessment of a covered institution’s risk profile and capital adequacy.
Barr suggests stress test changes may be coming
On December 1, Federal Reserve Board Vice Chair for Supervision Michael S. Barr signaled changes may be coming to the supervisory stress test standards for large banks, as the Fed evaluates whether the test used to set capital requirements reflects an appropriately wide range of risks. Speaking during an American Enterprise Institute event, Barr commented that the Fed is also “considering the potential for stress testing to be a tool to explore different sources of financial stress and uncover channels for contagion that lead to unanticipated consequences.” He added that the use of “multiple scenarios or adapting the stress test in other ways to better account for the high degree of interconnectedness between banks and other financial entities could allow supervisors and banks to identify those conditions and take action to address them.” Financial stability risks posed by the nonbank sector are also a strong concern for regulators, Barr said, commenting that many of these firms are undercapitalized and engage in high-risk activities. He stressed that the migration of activities from banks to nonbanks should be monitored carefully, and cautioned against lowering bank capital requirements “in a race to the bottom,” particularly since nonbank financial market stress is often directly and indirectly transmitted to the banking system. Banks must have sufficient capital to remain resilient to those stresses, Barr said.
FHFA orders stress tests for Fannie and Freddie
On March 16, FHFA published orders applicable March 10 for Fannie Mae and Freddie Mac (GSEs) with respect to stress test reporting as of December 31, 2021, under Dodd-Frank as amended by the Economic Growth, Regulatory Relief, and Consumer Protection Act. Under Dodd-Frank, certain federally regulated financial companies with total consolidated assets of more than $250 billion are required to conduct periodic stress tests to determine whether the companies have the capital necessary to absorb losses as a result of severely adverse economic conditions. The orders are accompanied by Summary Instructions and Guidance, which include stress test scenarios and revised templates (baseline, severely adverse, and variables and assumptions) for regulated companies to use when reporting the results of the stress tests (orders and instructions are available here). According to the Summary Instructions and Guidance, the GSEs have until May 20 to submit baseline and severely adverse results to FHFA and the Federal Reserve Board, and must publicly disclose a summary of severely adverse results between August 1 and 15.
Agencies release stress-test scenarios
Recently, the FDIC, Fed, and OCC released the hypothetical economic scenarios for use in the upcoming stress tests for covered institutions. The FDIC released supervisory scenarios, which include baseline and severely adverse scenarios. According to the FDIC, “[t]he baseline scenario is in line with a survey of private sector economic forecasters” while the “severely adverse scenario” is a “hypothetical scenario designed to assess the strength and resilience of financial institutions.” Likewise, the Fed released the results of its supervisory Dodd-Frank bank stress tests conducted on 34 large banks, which collectively hold 70 percent of bank assets in the U.S. The two scenarios, baseline and severely adverse, include 28 variables, such as GDP, unemployment rate, stock market prices, and mortgage rate. In the 2022 stress test scenario, the U.S. unemployment rate rises nearly 6 points to a peak of 10 percent over two years. The large increase in the unemployment rate is accompanied by a 40 percent decrease in commercial real estate prices, broadening corporate bond spreads, and a collapse in asset prices, including increased market volatility. The OCC also released the agency’s scenarios for banks and savings associations currently subject to Dodd-Frank stress tests.