A flurry of pre-holiday activity by the Federal Reserve’s Board of governors brings both good and bad news for large banks.
The worrisome word from Fed Governor Daniel Tarullo on Monday was that banks can expect their annual stress tests to be more stringent, with the potential for an increase to minimum capital requirements. “There is a pretty good chance” he told Bloomberg TV.
Those remarks were followed on Tuesday by the release of a proposed rule that would require large banks to publicly disclose several measures of their liquidity profile. Under the Liquidity Coverage Ratio (LCR) rule adopted by regulators in September 2014, banks with consolidated assets of $50 billion or more and certain depository institution subsidiaries are required to hold a minimum amount of high-quality liquid assets (HQLA) that can be easily and quickly converted into cash. The amount of HQLA held by each large banking organization must be equal to or greater than its projected net cash outflow during a hypothetical stress scenario lasting for 30 days. The ratio of the firm's HQLA to its net cash outflow is its LCR.
Under the proposed rule, large banking organizations would, for the first time, be required to disclose their consolidated LCRs each quarter based on averages over the prior quarter. Firms would also be required to disclose their consolidated HQLA amounts, broken down by HQLA category. Additionally, firms would be required to disclose their projected net cash outflow amounts, including retail inflows and outflows, derivatives inflows and outflows, and several other measures.
Comments on the proposed rule will be accepted through February 2, 2016.
Better news comes from a decision to extend the deadline for certain capital requirements by one year. On Wednesday, the Fed approved a final rule that modifies its capital plan and stress testing rules, effective for the 2016 capital plan and stress testing cycle.
The rule modifies the timing for several regulatory requirements that have yet to be integrated into the capital plan and stress-testing framework. Firms subject to the supplementary leverage ratio would begin to incorporate it into their capital plan and stress testing for the 2017 cycle. For stress-testing exercises, all firms would continue to use the generally applicable risk-based capital framework, but use of the advanced approaches risk-based capital framework, generally applicable to firms with at least $250 billion in total consolidated assets or $10 billion in on-balance sheet foreign exposures, would be delayed indefinitely. Those firms, however, would continue to be subject to the advanced approaches framework for their regulatory capital ratios.
The common equity tier 1 capital requirement in the Board's revised regulatory capital rules, intended to strengthen the quality and quantity of capital held by banks, will be fully phased in over the nine-quarter planning horizon of the 2016 capital plan and stress testing cycles. Generally, this ratio will require firms to hold more regulatory capital than the tier 1 common ratio, which was used before the introduction of the Board's revised regulatory capital rules. The final rule would remove the requirement for firms to calculate a tier 1 common ratio.
Banks that may be concerned by Tarullo’s comments earlier in the week may want to take note of a Fed statement that the “Board continues to review a broad range of issues related to its capital planning and stress testing rules” and any modifications will be undertaken through separate rulemaking and take effect no earlier than the 2017 cycle.
The Fed also announced that it is taking steps to enhance the supervision of large and complex banking organizations. The recommendations were developed after reviewing concerns of inconsistent supervisory procedures and an unclear process for resolve differing staff opinions.
While the review found that 95 percent of staff interviewed felt empowered to raise differing opinions, it noted that a formal process for raising divergent views did not exist. To address this, throughout 2016 the Fed will develop policies and practices to encourage these discussions.
The review also identified inconsistencies in documentation produced by supervisory teams and instances of inconsistent practices among the 12 regional banks. This triggered the establishment of minimum operating and documentation standards for all supervisory activities. The Fed is also developing a curriculum specifically tailored to the supervision of large financial institutions for its examiner training programs.