Fed has two options for improving 2018 capital proposal: Quarles
The Federal Reserve should adopt one of two options to improve its stress capital proposal in order to strengthen its overall capital regime, the central bank's top bank regulatory official said.
Federal Reserve Vice Chairman for Supervision Randal Quarles told a conference in Germany that either approach for improving the proposed stress capital buffer, SCB, would be equally effective.
Whereas the proposal required banks to pre-fund the following four quarters of planned dividends after a stress test, Quarles said, the final plan could either raise the minimum level of the SCB or raise the Fed’s countercyclical capital buffer, or CCyB, above zero “in normal times.”
“As an alternative to requiring pre-funding dividends and in furtherance of the other goals I have mentioned, I would like to suggest two co-equal options that, in my opinion, would simplify our capital requirements while limiting procyclicality,” Quarles said Thursday morning before the Program on International Financial Systems Conference in in Frankfurt. “Importantly, these two options also are consistent with our goal of maintaining overall levels of capital in the banking system."
The Fed’s SCB proposal would consolidate some of the many minimum capital requirements that banks have to meet into the stress testing program, and would also replace the fixed 2.5% risk-based capital buffer that banks are required to maintain at all times with the SCB, which is based in part on each bank’s performance in the prior year’s stress test.
Among the provisions in the proposal was a stress leverage buffer requirement, but Quarles said that he now thinks the inclusion of such a buffer is not suitable, because it would apply an unweighted leverage ratio into a broader risk-based capital regime.
“I am concerned that explicitly assigning a stressed leverage requirement to a firm on the basis of risk-sensitive post-stress estimates is in conflict with the intellectual underpinnings of the leverage ratio,” Quarles said. “It is what the analytical philosophers call a category mistake: like saying that, 'Freedom has curly hair.'"
The pre-funding of dividend and stock buybacks is also now seen as an unappealing provision in the SCB proposal, he said, because failure to pass the stress tests can result in limited distributions even though the same stress test requires those distributions to be pre-funded.
“I believe it is better to focus on the root cause of our concerns and take a comprehensive approach to ensuring that banks have sufficient capital, rather than focus on the individual elements of capital distributions,” Quarles said.
Raising the CCyB or the minimum SCB level, he said, would retain the countercyclical effect of pre-funding distributions, he said, though he did not specify how high the CCyB or the minimum SCB would need to be to offset the pre-funding of distributions. But in any event, either proposal would not result in an overall reduction of capital in the banking system.
“As I have stated, our goals remain to simplify our capital framework while maintaining the overall amount of capital in the U.S. banking system,” Quarles said. “The refinements we are considering to the SCB framework would also improve the efficiency, coherence, and transparency of the regulatory capital framework and the core principles of our stress testing program that have proven successful.”