New ‘stress capital buffer’ would simplify capital rules for large banks, ‘modestly’ reduce capital required for most

A proposal meant to simplify capital rules for large banks by introducing a so-called “stress capital buffer” (SCB) – which would largely “modestly” decrease the amount of capital required for most non-globally systemically important banks (non-GSIBs) – was issued by the Federal Reserve Tuesday.

In a release, the agency said “no firm is expected to need to raise additional capital as a result of this proposal,” issued for a 60-day comment period.

Under the proposal, the Fed said, the new SCB would in part integrate forward-looking stress test results with the Fed’s non-stress capital requirements. “The result would produce capital requirements for large banking organization that are firm-specific and risk-sensitive,” according to the Fed’s release.

Federal Reserve Board Vice Chairman for Supervision Randal Quarles said the proposal simplifies the central bank’s capital regime while “maintaining its strength.”

“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,” Quarles said.

Earlier this year, Quarles outlined his view that there is an opportunity to improve the efficiency, transparency, and simplicity of regulation. He said in February that now is the natural and expected time to evaluate the effectiveness of the post-crisis regulatory regime “with the benefit of hindsight and with the bulk of our work behind us.”

In today’s announcement, the Fed said its proposed SCB would be sized through the stress test, becoming part of the financial firm’s ongoing capital requirements. Large firms would be required to meet 14 capital-related requirements under the proposal, instead of the current 24.

(Now, the Fed pointed out, bank holding companies with more than $50 billion in assets undergo annual stress tests known as Comprehensive Capital Analysis and Review [CCAR], which require financial firms to demonstrate an ability to continue to lend under hypothetical, adverse conditions. Non-stress capital requirements are also required, the Fed noted.)

Providing an example, the Fed noted that if a firm has a common equity tier 1 capital ratio of 9%, but which falls to 6% under the hypothetical severely adverse scenario of the stress test, the firm’s SCB for the coming year would be 3%. The SCB would then be added to the minimum 4.5% common equity capital requirement, which remains unchanged, the Fed said.

“This would result in a 7.5% common equity capital requirement for the coming year,” the central bank said. “If the firm is a global systemically important bank (GSIB), its GSIB surcharge – an additional cushion of capital that is held by the largest banks – would be added to the SCB. Additionally, four quarters of planned dividends would be added to the SCB.”

GSIBs, the Fed said, would likely see the same or modestly increased amount of capital required under the proposal.

The agency also said its proposal would additionally modify several assumptions in the CCAR process to “better align them with a firm’s expected actions under stress.”

The agency said that, since the first round of stress tests in 2009, U.S. financial firms have substantially increased their capital; it pointed to the common equity capital ratio of the bank holding companies in the 2017 CCAR more than doubling from 5.5% in the first quarter of 2009 to 12.1% in the fourth quarter of 2017.

That, the Fed said, reflected an increase of more than $720 billion in common equity capital to a total of $1.2 trillion.

Federal Reserve Board seeks comment on proposal to simplify its capital rules for large banks while preserving strong capital levels that would maintain their ability to lend under stressful conditions