WASHINGTON — The Federal Reserve Board released a proposal Tuesday to modernize its stress testing regime by replacing many of the existing post-stress minimum capital levels with a so-called “stress capital buffer,” which officials say would simplify and refine the stress testing program.

Federal Reserve Vice Chairman for Supervision Randal Quarles said the proposal would simplify the Fed’s examination process in a way that does not generate additional risk to the financial system.

“Our regulatory measures are most effective when they are as simple and transparent as possible, and this proposal significantly simplifies our capital regime while maintaining its strength,” Quarles said in a press release. "It is a good example of how our work can be done more efficiently and effectively, and in a way that bolsters the resiliency of the financial system.”

Randal Quarles, Fed vice chair of banking supervision
"This proposal significantly simplifies our capital regime while maintaining its strength," said Federal Reserve Vice Chairman for Supervision Randal Quarles. Bloomberg News

The proposal, which will be subject to public comment for 60 days, would reduce the number of capital requirements that systemically important financial institutions are subject to as part of the Comprehensive Capital Review and Analysis stress test.

Currently, the Fed says SIFI banks with more than $50 billion in assets are subject to 24 different post-stress minimum capital standards. With the integration of the stress capital buffer, the total number of capital requirements would be reduced to 14.

The proposal draws heavily from a proposal sketched out by former Fed Gov. Daniel Tarullo in September 2016, which was the result of a years-long review of the stress testing regime. The concept of the stress capital buffer is that a bank’s performance in the prior year’s stress test determines how much capital it is required to retain in the current year.

Thus, a bank whose capital under a severely adverse scenario is reduced by relatively little would have to retain less capital the following year, while a bank whose capital is depleted more drastically would have to retain more.

Under the existing capital rules, SIFI banks have to retain at least 2.5% more common equity Tier 1 capital than they are required to have at any given time, known as the capital conservation buffer. At any time, if a Fed supervisor discovers that a bank’s capital level is at or even just above a minimum standard, that supervisor can require the bank to reduce dividend payments or stock repurchases.

The CCAR rules also require that banks retain those minimum capital levels even under hypothetical severely adverse conditions, and if they fail to do so, their dividend payments can be similarly curbed.

The Stress Capital Buffer would change those static minimum requirements — which are uniform across institutions — and replace them with a more dynamic ratio based on the bank’s last stress test results. The buffer would be composed of the banks’ maximum CET1 losses under the previous year’s severely adverse CCAR test, plus four quarters of planned dividend payments. The buffer could not be lower than 2.5% under the Fed’s proposal.

The stress capital buffer would replace the 2.5% capital conservation buffer and would be combined with any applicable G-SIB surcharge and/or countercyclical capital buffer to comprise the bank’s new uniform minimum capital requirement.

The proposal also includes a “stress leverage buffer” that would apply to a bank’s applicable leverage ratio. Banks undergoing the CCAR stress test are required to maintain a minimum of 4.5% capital against their total assets, regardless of the nature of those assets.

Under the proposal, that leverage ratio would be replaced with the difference between the firm’s non-stressed leverage and post-stress minimum leverage ratio. The Supplemental Leverage Ratio — an additional buffer applied to larger so-called “advanced approaches” banks — would remain unchanged.

The Fed estimated that banks designated as global systemically important banks, or G-SIBs, would have to retain an additional $10 billion to $50 billion in additional capital across all eight institutions, while other banks would likely have to reduce their capital levels by between $10 billion and $45 billion. The agency added that it did not believe, if applicable today, any firms would have to raise additional capital to be in compliance with the rules.

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