Fed close to finalise ‘stress capital buffer’ for banks

The Federal Reserve’s regulatory chief said the agency is close to finalising a “stress capital buffer” that could ease some of Wall Street’s biggest gripes about annual stress tests while boosting overall capital demands at the largest banks.The new measure will meld stress-test targets with day-to-day capital minimums, Randal Quarles, the Fed’s vice chairman for supervision, said on Thursday in remarks prepared for a European Central Bank event in Frankfurt. The Fed may also propose re-hashing another buffer meant to amp up capital when risk of a downturn is highest, Quarles said.Two of the most welcome developments for big banks in the plan outlined by Quarles would be ditching use of a certain leverage limit in evaluating stress-test outcomes and elimination of an assumption that banks would continue to pay steady dividends in a crisis.In April 2018, the Fed proposed tying risk-based capital requirements to the annual tests of banks’ ability to weather a future meltdown. The idea is to use a lender’s hypothetical losses from the stress tests as a buffer on top of its day-to-day capital minimum. While that would add to overall capital requirements for firms such as JPMorgan Chase & Co and Citigroup Inc, it would unite the two main capital constraints banks have been puzzling out separately.“Our goals remain to simplify our capital framework while maintaining the overall amount of capital in the US banking system,” Quarles said. He expects some of the changes to be in place for next year’s tests, but he said the Fed will seek public comment on any revisions to the original proposal.For smaller banks – including regionals such as SunTrust Banks Inc and Fifth Third Bancorp – the capital cushions could be reduced by tens of billions of dollars, because the full force of the Fed’s stress tests is aimed at their larger cousins.The Fed has been steadily reducing the difficulty of the stress tests, providing more transparency and trying to reduce the number of categories under which big banks are scored. Quarles’s effort to eliminate the assumption that banks need to set aside several quarters of dividends could have a major benefit.The agency has also been seeking to relegate existing limits on indebtedness – which has become a dominant restraint for some banks – to a role as a backstop. A leverage ratio that banks would have been required to stay above after accounting for stress-test losses is also being eliminated, Quarles said.Such boons could be offset by a proposal to activate the so-called counter-cyclical capital buffer. That buffer – which has never been used – is a measure of extra capital that can be activated as economic risks are elevated.Quarles suggested two options: Either put it in place as an add-on to the stress capital buffer and let it be raised or lowered depending on economic stress, or simply raise the floor of the overall stress capital buffer.Additional Tool Putting in an easier-to-adjust counter-cyclical buffer would be “a helpful, additional tool that could be adjusted quickly in response to economic, financial, or even geopolitical shocks,” Quarles said.In the end, each bank would be looking at a day-to-day capital cushion that will include several components: longstanding base amounts, the new buffer based on stress-test performance, a counter-cyclical buffer and an existing surcharge based on how systemically important and complex they are.The Fed has been racing to finish some of the major initiatives undertaken by regulators appointed by President Donald Trump, and Quarles had said much of the work could be finished by late this year. The agency is poised to sign off on a major revision of the Volcker Rule already approved by other regulators, and it’s close to finishing a set of “tailoring” rules that reset capital, liquidity and leverage requirements based on banks’ size and complexity.