Stress capital buffer final rule due soon; parts will be re-proposed, effective date won’t be before 2020, Quarles says

The Federal Reserve will likely soon adopt a final rule on its stress capital buffer (SCB) proposal, but will also likely re-propose certain elements for the rule – resulting in the first SCB not going into effect before 2020, the Federal Reserve’s top regulatory supervisor said Friday.

In a speech at the Brookings Institution in Washington, D.C., focusing on the Fed’s stress testing program and the Comprehensive Capital Analysis and Review (CCAR), Federal Reserve Vice Chairman for Supervision Randal Quarles said he doesn’t believe that reissuing portions of the proposal “will prevent us from ultimately implementing the SCB.” However, he said that – during the comment period on the proposal – commenters have “flagged certain elements of the regime that could benefit from further refinement.”

“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 said.

(In the 1-minute video, FRB Vice Chair Quarles comments on forthcoming proposals on capital for financial firms, and the agency’s approach to developing them.)

He also said he would ask the Federal Reserve Board to exempt firms with less than $250 billion in assets from the CCAR quantitative assessment and supervisory stress testing in 2019 “in light of the every-other-year cycle contemplated in the tailoring proposal that the board approved two weeks ago.”

The SCB, proposed in April, integrates stress-test results – which the Fed has termed “forward looking” – with the agency’s non-stress capital requirements. The Fed hopes the results would produce capital requirements for large banking organizations that are firm-specific and risk-sensitive. The proposal closed for comments in June; the comments are now being considered by the Fed in finalizing the rule.

However, as Quarles said Friday, a key issue brought forward by commenters is that the results of the supervisory stress test can lead to capital requirements that change significantly from year to year, which can limit a firm’s ability to manage its capital effectively.

“Some amount of volatility is necessary to preserve the dynamism of the stress test – by nature, the stress test will differ year-over-year based on macroeconomic conditions and contemporary understanding of salient risks in the economy,” Quarles said. “However, I do think there is an important balance to be struck between preserving this dynamism and ensuring that firms have sufficient notice regarding the capital requirements to which they are held.”

Additionally, Quarles said he would ask the Fed Board to adjust operation of the final rule so that firms know their SCB before they decide on planned distributions of income for the coming year.

“This adjustment in sequence will also help firms manage volatility in the SCB,” he said. “We expect firms to continue to maintain robust stress testing practices and use those results to inform their capital distribution plans, and we will continue to use the supervisory process to reinforce this expectation.”

In other comments, the Fed’s top supervisory official said his agency would soon issue a policy statement describing governing principles around the supervisory stress testing process, including a commitment by the Fed to disclose additional detail about supervisory stress test models and results, and to publish portfolios of hypothetical loans and associated loss rates.

“I expect that we will begin providing some of this additional detail starting in early 2019, and that these changes will allow firms to benchmark the results of their own models against those of the supervisory models,” he said.

He also said the Fed is considering “options” to provide additional transparency regarding stress-test scenarios and design and that the Fed will likely seek comment on the advisability of and possible approaches to gathering the public’s input on “scenarios and salient risks facing the banking system each year.”

Speech by Vice Chairman for Supervision Quarles on a new chapter in stress testing

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