Fed to delay new big-bank capital measure until 2020: Quarles

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WASHINGTON — The Federal Reserve’s top regulator said Friday that the agency is not planning to finalize a new capital measure used in stress tests in time for next year's round of capital assessments for the biggest banks.

Speaking at the Brookings Institution Friday morning, Fed Vice Chairman for Supervision Randal Quarles said the so-called Stress Capital Buffer — or SCB — will probably be in place for the 2020 stress tests “at the earliest.”

The capital buffer is designed to make the capital rules less complicated by replacing the various minimum capital ratios now used with fewer standards that better reflect a bank’s actual risk of losses.

Quarles said the agency has received “extensive and thoughtful” comments in response to its proposal and that those comments will likely result in some additional refinements in the final rule. He said the Fed will likely finalize the basic framework first and then propose additional aspects in a future rule.

“While I don’t believe these issues will prevent us from ultimately implementing the SCB, they have flagged certain elements of the regime that could benefit from further refinement,” Quarles said. “I expect we will adopt a final rule in the near future that will settle the basic framework of the SCB, but re-propose certain elements.”

The stress capital buffer is an idea that was first articulated by former Fed Gov. Daniel Tarullo in the months before he resigned from the board. The SCB would be a component of a bank’s minimum capital requirement that reflects model losses from the prior year’s stress test. That way, a bank with fewer losses would be required to comply with lower minimum capital requirements than a bank that suffered higher losses.

The effect of a more protracted timeline for the SCB is that, rather than being in place in time for the 2019 stress testing cycle, it will likely not be fully in place until 2020, though some aspects of the proposal may be implemented in time for next year’s cycle.

“To enable this process to run its course, I expect that the first SCB would not go into effect before 2020,” Quarles said. “For 2019, I expect CCAR will remain in place for firms with over $250 billion in assets or that are otherwise complex; however, we will consider whether we can move forward with any aspects of the SCB proposal for CCAR 2019, such as assumptions related to balance sheet growth.”

Quarles also said that the Fed is looking to reduce the degree to which the stress test — and the changes in the stress scenarios from year to year — dictate a bank’s annual capital planning. Some volatility is necessary, he said, but the Fed is looking for ways to communicate its expectations to regulated banks without having the firms dictate the terms of the stress test. The Fed is going to issue a proposal on how to do that “in the not-too-distant future,” Quarles said. He also said the Fed is considering releasing additional information about the Fed’s stress scenarios, as well as whether to put those scenarios out for public comment.

Banks have also argued that one challenge of the stress test is that it requires them to decide on their capital distribution plans before they know the outcome of the test; therefore, the challenge is to develop a capital plan that is market competitive but that does not run afoul of the stress test. Quarles said that he intends to ask the Fed board to adjust the timing of the stress test so that banks know their SCB requirement before they make their annual distribution plans.

“I am sympathetic to their concerns, and will ask the board to adjust the operation of the rule so that firms know their SCB before they decide on their planned distributions for the coming year,” Quarles said. “This adjustment in sequence will also help firms manage volatility in the SCB.”

Quarles also reiterated a preference he made before the House Financial Services Committee earlier this year that the qualitative objection of the stress test be phased out and made part of a bank’s routine supervision. While the Fed would retain the ability to object to a bank’s internal risk controls or models — objections that typically are the basis of qualitative objections in the Comprehensive Capital Analysis and Review stress test — they would do so as part of normal bank supervisory actions rather than as a public exercise.

“It would simply remove the public shaming element of the qualitative objection,” Quarles said.

Other highlights from Quarles’ remarks:

  • Quarles said the Fed doesn’t view the countercyclical capital buffer as a “macroeconomic damper” for cooling a hot economy, but rather is designed to be implemented “when we think financial stability risks are meaningfully above normal.” He said the Fed is continually monitoring those risks and will take action when it believes it is warranted.
  • The Financial Stability Oversight Council may have de-designated its last nonbank SIFI, Quarles said, but it is still considering how and whether to recommend rules to rein in systemically risky activities, Quarles said. “It is a tricky thing to do, but is in fact being quite diligently and rigorously pursued by the FSOC,” he said.
  • Quarles pushed back against the argument that its proposals are intended to reduce capital and liquidity in the banking sector, saying that bank regulators — including the Fed — are making adjustments to the post-crisis framework meant to increase efficiency and reflect changes in the market. “The changes … are not intended to alter materially the overall level of capital in the system or the stringency of the regime,” Quarles said.
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