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From Banking and Finance Law Daily, April 11, 2018

Fed proposes large bank capital rule simplification

By Richard A. Roth, J.D.

The Federal Reserve Board is proposing amendments to its capital, capital plan, and stress test rules that it believes will simplify large banks’ capital planning processes without reducing the industry’s current strong capital levels. The proposal would create two new concepts, the stress capital buffer and the stress leverage buffer. It also would integrate each bank’s Comprehensive Capital Analysis and Review results with the capital rule requirements in a way that would reduce the number of capital-related requirements a bank must meet from the current 24 down to 14.

According to the Fed, smaller banks that are subject to the CCAR and stress test rules might see reductions in their required capital levels due to the changes. Required capital levels for global systemically important banks generally would remain the same, but a few GSIBs might see slight increases.

Stress capital buffer. A staff memo released by the Fed says that each bank would calculate a stress capital buffer (SCB) based on its CCAR results. The decrease in the firm’s common equity tier 1 capital ratio under the severely adverse scenario would be added to four quarters of planned common stock dividends, and that total would be the bank’s required SCB. However, the SCB would never be less than 2.5 percent of the bank’s risk-weighted assets.

The SCB then would be added to any applicable GSIB surcharge and countercyclical capital buffer to yield the firm’s standardized approach capital conservation buffer. The memo says this would make the standardized approach capital conservation buffer sensitive to both the bank’s vulnerability to stress—through the SCB—and its potential to harm the financial system—through the GSIB surcharge.

Stress leverage buffer. The stress leverage buffer (SLB) would be the difference between the bank’s starting and minimum projected tier 1 leverage ratio under the severely adverse scenario, added to the same four quarters of planned dividends. According to the memo, this would maintain the current relationship between the risk-based and leverage capital requirements in normal and stress conditions.

The SLB would replace the CCAR requirement that the bank show that it can maintain a capital level that is higher than the minimum leverage requirement post-stress.

Test, CCAR assumption changes. The proposal also would change some of the assumptions made by the supervisory stress test and CCAR.

First, it currently is assumed that a bank will carry out all of its planned dividends, share repurchases, and regulatory capital instrument issuances. However, the introduction of the SCB would make the bank’s ongoing capital distributions dependent on its performance under stress. For that reason, the CCAR no longer would assume that any capital instruments will be repurchased or redeemed.

According to the memo, history shows that, under stress, repurchases will be reduced or stopped before the payment of common share dividends. For this reason, the payment of four planned quarterly dividends would be assumed.

Second, the supervisory stress test rule would change the assumption it uses to approach balance sheet projections. Currently, the test assumes that loan supplies will remain constant under stress, while loan demand will change to reflect the scenario’s economic conditions. This generally brings about growth in a bank’s projected total assets and is intended to look at whether the firm has enough capital to handle stress without reducing the availability of credit.

This assumption has come under question, as firms have given examples of situations in which it is unrealistic, the Fed says. As a result, the proposal would change the stress test to assume that banks will take appropriate actions to maintain a constant asset level, as opposed to projecting asset growth.

Third, the Fed no longer would object to a bank’s capital plan based on a quantitative assessment of the bank’s capital adequacy. Since the SCB will impose appropriate capital distribution limits, a quantitative adequacy objection would be unnecessary.

However, objections based on qualitative assessments would remain possible.

The proposal will be subject to a 60-day comment period after it is published in the Federal Register.

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