Analysis of the resilience of globally systemically important banks to the failure of their largest hedge funds will be published by the Federal Reserve when results of stress tests of the largest banks are revealed this summer, the agency’s top supervisor said Tuesday.
Speaking at the Basel Committee on Banking Supervision-Federal Reserve Counterparty Credit Risk Conference, New York, N.Y., Fed Board Vice Chair for Supervision Michael Barr said the results of the “exploratory analyses” of the counterparties would focus on the five largest hedge funds of the banks.
“We will conduct that analysis under two different sets of financial market conditions to learn about how such exposures may vary across different types of stresses,” Barr said. “We expect the information yielded from that analysis will deepen our supervisory understanding of counterparty credit risk at the banks.”
He said the exploratory analysis would not affect bank capital requirements, as noted when the scenarios for this year’s stress tests were announced Feb. 15.
Barr said that there would be more to come on the exploratory analysis in June.
In other comments, Barr said the Fed plans to continue its focus on fundamental risk management related to counterparty credit risk. He listed areas for banks to be ready to consider in that focus, including that: Banks should know their customers exceedingly well, banks should have tools to identify the unique risks that they face, and banks should set prudent risk limits.
“These risk management practices are important to help control the build-up of risk—preventing banks and the banking system from taking on outsized exposure to leveraged entities and preventing the build-up of that leverage,” Barr said.
“These credit risk management practices are important complements to prudent liquidity risk management and resilience measures, such as contingency planning, in which banks take steps to mitigate the impact of distress of a counterparty to the bank and the financial system more broadly.”