WASHINGTON The Federal Reserve Board unexpectedly issued a proposal Friday that would make significant changes to its stress tests, including eliminating or delaying several capital ratios that the largest banks are required to meet in order to pass.
The plan would alter the Comprehensive Capital Assessment and Review, which the largest banks must take annually to ensure they can withstand a period of economic stress. The agency said it is always looking for ways to improve the exercise and would apply these changes to next year's test if the plan is finalized.
"The board notes that is considering a broad range of issues relating to the capital plan and stress test rules, including how the rules interact with other elements of the regulatory capital rules and whether any modification may be appropriate," the proposed rule said.
CCAR is seen by many banks as the most significant supervisory hurdle they face following the financial crisis. The Fed views it as a critical tool for getting insight into how the largest banks might perform in volatile financial events.
CCAR requires each bank with more than $50 billion in assets to submit enormous quantities of data to the Fed, which then examines how each bank's balance sheet and capital plan performs over nine future quarters under hypothetical global financial conditions of varying degrees of severity. To pass CCAR, each bank has to maintain regulatory capital minimums throughout the nine-quarter cycle. If a bank fails, it may be prevented from paying out dividends for that year.
The proposal would eliminate the need to comply with a Tier 1 common capital ratio. The Fed said that the CCAR's Tier 1 Common Equity ratio is similar but more stringent. The agency added that the Tier 1 Common ratio was always intended to be a stopgap for banks while the Fed completed its work on the Tier 1 Common Equity capital ratio.
"The common equity Tier 1 capital ratio generally is expected to be more binding than the Tier 1 common ratio under the severely adverse scenario because of the regulatory capital rule's stringent capital deductions, most of which will be fully phased-in by the end of the next planning horizon," the proposal said. "Removing the Tier 1 common ratio requirement will further reduce the burden of maintaining legacy systems and processes necessary for calculating the Tier 1 common ratio."
The proposal would also allow banks with so-called "advanced approaches" to calculate their minimum regulatory capital requirements. Basel III allows banks to elect to use their own regulatory capital calculators in lieu of the standard one used by the Fed, but only if the central bank approves it and deems it to be more stringent and sophisticated.
Only banks with either $250 billion in assets or $10 billion in foreign assets may opt for the alternative calculator, and currently nine banks Wells Fargo, Citigroup, Goldman Sachs, JPMorgan Chase, Bank of New York Mellon, Morgan Stanley, Northern Trust, U.S. Bancorp and State Street have won approval of their advanced approaches.
Under the proposal, those banks will have a one-year delay of the application of a required supplementary leverage ratio, so it will not be applicable for their stress tests until 2017. The Fed said that a change in the timing of the capital planning and stress test cycles announced last October makes it necessary for banks with their own capital adequacy processes to receive more time to develop the required systems.
Another provision of the plan would bar banks from using their advanced approaches calculator to determine risk-based capital standards for the purposes of the test. Banks expressed concerns that using both standardized and advanced approaches to calculate their ratios would "require significant resources and would introduce complexity and opacity." The Fed said that it needs to more thoroughly examine the interaction between regulatory capital rules and the stress tests before the advanced approaches can be used.