WASHINGTON — Federal Reserve Board Gov. Daniel Tarullo said Wednesday that banks will need to continue to improve their capital planning processes as part of their annual stress test exercise.

"Some firms still lack reliable information about their businesses and exposures," said Tarullo in prepared remarks at a conference hosted by the Federal Reserve Bank of Boston. "Firms also are sometimes unable to measure or understand how stressful conditions can change the performance of their material business lines."

In particular, Tarullo noted that at many firms, the ability to assess potential tail risks still requires further development.

"These deficiencies are, in some instances, compounded by weak oversight by senior management and board of directors, and lack of effective checks and accountability in the process," said Tarullo.

Still, Tarullo, who heads bank supervision for the Fed, noted that there have been considerable improvements by firms in their capital planning process.

Many have made significant investments in their risk-measurement processes such as internal data and management information systems. Others have adopted a framework to inform their capital planning by analyzing the firm's vulnerabilities and capital adequacy under a number of possible adverse scenarios.

But the expectation by the Fed is that firms will do better each and every year.

"Many firms had a long way to go to meet high standards of capital planning backed by strong risk management when we began CCAR," said Tarullo. "What may be perceived as a raising of the bar every year is better understood as our effort to provide a demanding, but still realistic, glide path for firms to reach that goal.

"We do, however, expect firms to continue to make steady progress each year."

The so-called "qualitative" aspect of the Fed's yearly stress test and capital planning process for the country's 30 largest firms has become a focal point of the exercise. This year the Fed rejected capital plans of five firms for deficiencies in their capital planning process, including four for qualitative reasons -- Citigroup, HSBC North America, RBS Citizens Financial, and Santander.

For the Fed, inadequate capital planning raises a red flag in a firm's ability to adequately assess its ability to withstand stress in the event of another financial crisis.

Because of its importance, Tarullo said such qualitative assessments would continue to be integrated into year-round supervision of the firms who undergo yearly stress tests.

"While some important features of capital planning are observable only during the formal CCAR process, most of the risk-management and capital planning standards incorporated in CCAR are operative and observable by supervisors throughout the year," said Tarullo. "These should be an important focus of ongoing supervisory oversight and of discussions between firms and supervisors."

He added that only in "unusual circumstances" should a supervisor become aware of a significant problem in a bank's capital planning process. Similarly, firms should not generally be surprised of the outcome of their qualitative assessment, he said.

At the end of the each CCAR process, the Fed sends a letter to each firm detailing the conclusion of its qualitative assessment, which is meant to serve as a starting point for firms to take stock of their risk management practices.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.