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From Banking and Finance Law Daily, February 8, 2017

Will capital buffers affect CCAR stress testing?

By John M. Pachkowski, J.D.

The Office of Financial Research has released a brief, authored by Jill Cetina, Bert Loudis, and Charles Taylor, that discusses how new capital buffers adopted by the banking regulators might affect the stress tests conducted as part of the Federal Reserve Board’s Comprehensive Capital Analysis and Review (CCAR).

The capital buffers, which were adopted in the beginning of 2016 and are scheduled to be fully phased in by 2019, are intended to help banks absorb unexpected losses. The capital conservation buffer applies to all U.S. banks and is designed as a safety margin to reduce the chance banks will fall below regulatory minimums. The countercyclical capital buffer is a temporary buffer that the Fed can require based on economic conditions and applies to 16 advanced-approaches banks. Finally, the G-SIB buffer applies to eight banks that the Fed has deemed to be global systemically important banks and is intended to reduce the chance that one of these eight banks fails thereby causing broad disruptions in the financial system.

In September 2016, Fed Governor Daniel K. Tarullo, speaking before the Yale School of Management Leaders Forum, suggested that capital buffers might be integrated into the CCAR in a future rulemaking.

The OFR brief noted that, if the capital buffers are to be included in the CCAR stress tests, some banks will need to hold more capital to pass stress tests.

The brief’s authors were more concerned about another potential change—permitting banks to use static balance sheets (that is, balance sheets unchanged from the prior period). If permitted to be used in stress tests, the change could make the tests less effective. A number of effects that the use of static balance could have on the CCAR are that banks could fail to have enough capital to extend new credit under stress and impede integration of funding shocks into the CCAR.

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