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 (#Gotbitcoin?)
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.
Fed Considers New Tool For A Downturn
The countercyclical capital buffer would require banks to hold more capital should the economy show signs of overheating.
Federal Reserve officials are weighing whether to use a tool that could reduce the risk of a credit crunch in a downturn.
The tool is known as the countercyclical capital buffer. It allows the Fed to require banks to hold more loss-absorbing capital should the economy show signs of overheating, or to keep less of it during bad economic times. The buffer applies generally to banks with more than $250 billion in assets, including firms such as JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc.
The Fed’s board of governors so far hasn’t used the tool, approved in 2016. Its rule on the buffer says it should turn it up when economic risks are “meaningfully above normal” and reduced when they “abate or lessen.”
Now, some Fed officials are debating whether it is time to use the tool, which could provide banks with additional lending firepower in a subsequent downturn. It isn’t clear when they might make a decision.
“The idea of putting it in place so you can cut it, that’s something some other jurisdictions have done, and it’s worth considering,” Fed Chairman Jerome Powell said at a late July press conference.
Deciding whether to use the buffer is somewhat fraught, though. Banks are reluctant to hold even more capital than they do today as this could hamper their profitability. That is already under strain due to low interest rates.
Plus, it isn’t clear how markets would interpret such a move by the Fed, especially since this would be a first. Investors could find the buffer reassuring, believing the Fed is giving itself additional room to fight a downturn. Or they could be unsettled by it, fearing the Fed believed a slowdown is imminent.
Fed officials have been debating about whether to use the tool since last year. Now, they are raising another question: how it should be used.
Some officials have suggested turning it on without increasing capital levels—signaling the Fed is prepared to use the tool, even if not right away. Others think higher capital requirements should be applied now.
Either move would give the central bank the option of lowering the requirement during a downturn.
Fed Gov. Lael Brainard, an Obama appointee, favors turning on the buffer now and raising capital requirements for big banks. She dissented from a March Fed vote to leave the buffer dormant.
“Turning on the [buffer] would build an extra layer of resilience and signal restraint, helping to damp the rising vulnerability of the overall system,” she said in a May speech.
Others say capital levels are already high enough, and that the tool could be used instead as a release valve for bad times.
“We rely on through-the-cycle, always on, high capital and liquidity requirements,” Mr. Powell said. “I view the level of capital requirements and the level of capital in the system as being about right.”
Randal Quarles, the Fed’s vice chairman for bank supervision, at a July Fed conference in Boston said, “The overall risk to financial stability is swamped by the extremely low leverage in the financial sector. ”
Messrs. Quarles and Powell have cited the Bank of England’s approach as a possible model for the U.S. In the U.K., the countercyclical capital buffer is set at 1% of risk-weighted assets when risks are “neither subdued nor elevated,” allowing the central bank to dial it down if the economy is thrown a curveball.
Banks have argued the buffer shouldn’t be turned on now because they are already subject to regulations, including other capital requirements, that ensure they are prepared for bad times. One example is the Fed’s annual stress tests that banks must pass to prove they would continue lending in a recession.
At the same time, they have encouraged the Fed to reduce other capital requirements. The central bank would likely have to do that if it activated the countercyclical capital buffer while maintaining the same amount of capital in the banking system, as suggested by Messrs. Powell and Quarles.
The countercyclical capital buffer was created in 2010 by international regulators through the Basel Committee on Banking Supervision. It is being used in other parts of the world, including Sweden and Hong Kong. Fed To Further Overhaul,Fed To Further Overhaul,Fed To Further Overhaul,Fed To Further Overhaul,Fed To Further Overhaul,Fed To Further Overhaul