Fed To Further Overhaul Stress-Testing Regime, Making It Easier For Banks To Pass (#Gotbitcoin?)
Regulator aims to make test scenarios more consistent from year to year, Quarles says. Fed To Further Overhaul Stress-Testing Regime, Making It Easier For Banks To Pass
The Federal Reserve plans to broaden its proposal to ease stress tests for the nation’s largest banks with changes that could reduce the chance they fail the annual assessments.
Fed Vice Chairman of Supervision Randal Quarles in a Friday speech said the agency was considering revisions that could make the test scenarios more consistent from year to year and give firms their results before they wrap up shareholder-return plans. Big banks must pass the Fed’s stress tests to be able to make shareholder payouts, although the timing of the test results means banks set those plans before knowing how they performed.
“It is prudent to review all our practices,” Mr. Quarles said in prepared remarks for a speech in Washington, “in light of changes in the industry that have been achieved.”
The changes under consideration “are not intended to alter materially the overall level of capital in the system,” he said. Some of the revisions are expected “in the not-too distant future,” he added.
Banks will likely welcome what Mr. Quarles outlined as a sweetening of an April proposal that was already set to ease the stress-testing burden.
“We believe this should permit mega banks to boost distribution levels while reducing the risk of an unexpected” stress-test result, Cowen & Co. analyst Jaret Seiberg said in a note to clients.
Mr. Quarles also recommended that financial institutions with less than $250 billion in assets, which include SunTrust Banks Inc. and Fifth Third Bancorp , should skip the 2019 tests as they are set to enter a two-year evaluation schedule under a different Fed proposal.
Each year, banks’ balance sheets must run through a hypothetical doomsday scenario presented by the Fed that measures whether banks could keep lending during a severe downturn. Some years present tougher challenges than others, and banks have complained it is hard to adjust capital levels to a moving target. The latest round in June was the toughest to date, and Goldman Sachs Group Inc. and Morgan Stanley almost failed.
Mr. Quarles said the Fed was considering addressing a key roadblock for banks in the stress tests: receiving results after making plans for the following year’s shareholder dividends and share buybacks. This puts them at risk of paying less to shareholders than they actually could, or failing the tests if they distribute too much, Mr. Quarles said.
“Firms have told us that they would be able to engage in more thoughtful capital planning” if they got the results before making payout plans, Mr. Quarles said. Such a change could effectively eliminate the possibility that a bank gets publicly shamed by failing the tests.
Mr. Quarles recommended eliminating a capital requirement known as the leverage ratio from the stress tests. That would be a significant change, as some banks have been tripped up by that part of the tests in years past. Mr. Quarles said the leverage ratio, which compares equity to total assets and doesn’t take into account the relative riskiness of different bank loans and investments, might not be consistent with the “risk-sensitive” stress tests.
The Fed official also proposed modifying capital buffers, which force banks to gradually build up capital when they edge close to the Fed’s minimum. Buffers require big banks to sock away additional capital during good times so they have more to fall back on during bad times.
Existing buffers are too tough “in our current world in which a healthy and profitable banking system is seeking to maintain its capital levels rather than continue to increase them,” Mr. Quarles said.
He also said stress tests should be more transparent, suggesting for instance that the Fed seek public input as it crafts doomsday scenarios. He acknowledged giving banks more information up front could create an opportunity for banks to game the tests. But after the speech, he said more disclosure about the test was akin to giving the banks a textbook to prepare for the tests, not the test questions.Go back