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Prudential Regulators Finalize Midsize Bank Stress Test Guidance
On March 5, the Federal Reserve Board, the OCC, and the FDIC issued final guidance for stress tests conducted by banking institutions with more than $10 billion but less than $50 billion in total consolidated assets. Under Dodd-Frank Act-mandated regulations adopted in October 2012, such firms are required to conduct annual stress tests. The guidance discusses (i) supervisory expectations for stress test practices, (ii) provides examples of practices that would be consistent with those expectations, and (iii) offers additional details about stress test methodologies. Covered institutions are required to perform their first stress tests under the Dodd-Frank Act by March 31, 2014.
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.
Federal Reserve Board Issues Guidance On Risk Transfers
On December 20, the Federal Reserve Board issued SR 13-23, which clarifies the Federal Reserve’s supervisory expectations when assessing a firm’s capital adequacy in certain circumstances when the risk-based capital framework may not fully capture the residual risks of a transaction. The letter states that, while the Federal Reserve generally views a firm’s engagement in risk-reducing transactions as a sound risk management practice, there are certain risk-reducing transactions for which the risk-based capital framework may not fully capture the residual risks that a firm faces on a post-transaction basis. The letter addresses two specific characteristics of risk transfer transactions that give rise to this concern: (i) a firm transfers the risk of a portfolio to a counterparty that is unable to absorb losses equal to the risk-based capital requirement for the risk transferred; or (ii) a firm transfers the risk of a portfolio to an unconsolidated, “sponsored” affiliate entity. The letter stresses that bank supervisors will strongly scrutinize risk transfer transactions that result in substantial reductions in risk-weighted assets, including in supervisors’ assessment of a firm’s overall capital adequacy, capital planning, and risk management through the Comprehensive Capital Analysis and Review. The Federal Reserve may in certain cases determine not to recognize a transaction as a risk mitigant for risk-based capital purposes. Supervisors will evaluate whether a firm can adequately demonstrate that the firm has taken into account any residual risks in connection with the transaction.
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.
Prudential Regulators Propose Leverage Ratio Rule
On August 20, the Federal Reserve Board, the OCC, and the FDIC proposed a rule to strengthen the leverage ratio standards for the largest U.S. banking organizations. The proposed rule is the same as that approved last month by the FDIC and the OCC. The rule would require bank holding companies with more than $700 billion in consolidated total assets or $10 trillion in assets under custody to maintain a tier 1 capital leverage buffer of at least 2% above the minimum supplementary leverage ratio requirement of 3%, for a total of 5%. Failure to exceed the 5% ratio would subject covered companies to restrictions on discretionary bonus payments and capital distributions. The proposed rule also would require insured depository institutions of covered holding companies to meet a 6% supplementary leverage ratio to be considered “well capitalized” for prompt corrective action purposes. The proposal suggests a phase-in period for the rule with an effective date of January 1, 2018. Comments on the proposal are due by October 21, 2013.
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.
Governor Duke Announces Resignation from Federal Reserve Board
On July 11, the Federal Reserve Board announced that Governor Elizabeth Duke submitted her resignation effective August 31, 2013. She was appointed to the Board in August 2008 to fill a term that expired January 31, 2012. During her time on the Federal Reserve Board, Ms. Duke, a former community banker, focused on housing issues and financial regulation, including with regard to the impact of such regulation on community banks. For example, last year she cautioned regulators about the potential impact of the various mortgage and capital rules on small institutions. Ms. Duke, who also previously led the American Bankers Association, did not indicate her future plans.
Prudential Regulators Finalize Regulatory Capital Rule, Propose New Leverage Ratio for Large Banks
On July 9, the FDIC and the OCC approved a final rule to implement the risk-based and leverage capital requirements in the Basel III framework and relevant provisions mandated by the Dodd-Frank Act. The same rule was approved on July 2 by the Federal Reserve Board. The final rule (i) increases the minimum common equity tier 1 capital requirement from 2% to 4.5% of risk-weighted assets; (ii) increases the minimum tier 1 capital requirement from 4% to 6% of risk-weighted assets; and (iii) adds a new capital conservation buffer of 2.5% of risk-weighted assets. The rule also establishes a minimum leverage ratio of 4% for all banking organizations. In response to concerns raised by smaller and community banking organizations, the regulators did not finalize more onerous capital requirements that would have substantially increased the risk-weightings for residential mortgages, as explained in more detail in our recent post. The final rule does not change the more stringent limits on the inclusion of mortgage servicing assets and deferred tax assets in regulatory capital calculations, but does extend the phase-in period for community banks. Internationally active banks must begin to implement the new capital rules in January 2014, while all other banking organizations will have until January 2015 to begin to phase in the new capital requirements. Also on July 9, the FDIC and the OCC approved a proposed rule that would require bank holding companies with more than $700 billion in consolidated total assets or $10 trillion in assets under custody to maintain a tier 1 capital leverage buffer of at least 2% above the minimum supplementary leverage ratio requirement of 3%, for a total of 5%. Failure to exceed the 5% ratio would subject covered companies to restrictions on discretionary bonus payments and capital distributions. The proposed rule also would require insured depository institutions of covered holding companies to meet a 6% supplementary leverage ratio to be considered “well capitalized” for prompt corrective action purposes. The proposal suggests a phase-in period for the rule with an effective date of January 1, 2018. Comments on the proposal are due 60 days after it is published in the Federal Register.