Federal Reserve Board Proposes Rule Amending Certain Aspects of Existing Capital Plan and Stress Test Rules

On July 17, the Board of Governors of the Federal Reserve System (the “FRB”) released a notice of proposed rulemaking (the “NPR” and the rules set forth therein, the “Proposed Rule”) that would modify certain aspects of the FRB’s capital plan rule (the “Capital Plan Rule”)1 and Dodd-Frank Act stress test rules (the “DFAST Stress Test Rules”)2 applicable to large bank holding companies (“BHCs”)3 and certain banking organizations with total consolidated assets of more than $10 billion. The NPR would also affect elements of the FRB’s supervisory Comprehensive Capital Analysis and Review (“CCAR”) process. The proposed changes would apply beginning with the 2016 capital planning and stress testing cycles, and include:

  • Suspension of incorporation of the advanced approaches for capital plan and stress test purposes: For advanced approaches banking organizations that must calculate their minimum regulatory capital requirements using both the standardized and advanced approaches, the Proposed Rule would delay “until further notice” the use of the advanced approaches for calculating risk-based capital requirements for purposes of the capital plan and stress testing framework. Responding to industry concerns that incorporating the advanced approaches into stress testing “would require significant resources and introduce complexity and opacity,” the FRB is proposing to delay this requirement, pending a “broader review” of the interaction of the Capital Plan and DFAST Stress Test Rules with the regulatory capital rules.
  • Elimination of Tier 1 common ratio calculation and minimum requirement: The 2013 revisions to the U.S. regulatory capital rules4 include a new minimum common equity tier 1 (“CET1”) capital requirement of 4.5 percent of risk-weighted assets. This CET1 ratio requirement was fully phased in as of January 1, 2015, making the 2016 capital plan and stress test cycle the first cycle for which banking organizations will be fully subject to the CET1 ratio. The CET1 ratio requirement is generally expected to be more binding on subject banking organizations than the former tier 1 common ratio under the severely adverse scenario. As a result, the Proposed Rule would eliminate the requirement that a banking organization demonstrate its ability to also maintain a pro forma tier 1 common capital ratio of 5 percent of risk-weighted assets under baseline and stressed scenarios.
  • Delayed implementation of the U.S. supplementary leverage ratio (“SLR”) requirement: The SLR applies only to advanced approaches banking organizations and becomes effective as a minimum capital requirement on January 1, 2018. The Proposed Rule would delay the incorporation of the SLR into the capital plan and stress testing framework for one year. As a result, subject banking organizations would not be required to include an estimate of the SLR for capital plan and stress test cycle beginning on January 1, 2016. This change is proposed to provide additional time for subject banking organizations to develop the systems necessary to project the SLR in light of the October 2014 revisions to the Capital Plan and DFAST Stress Test Rules, which changed the commencement date of the capital plan and stress test cycles and would otherwise have required the inclusion of SLR estimates for the ninth quarter of the 2016 capital planning and stress testing horizon.
  • Modification of capital action assumptions: The DFAST Stress Test Rules currently require large BHCs (that is, those with consolidated total assets of $50 billion or more) to assume that they do not issue capital or redeem instruments in the second through ninth quarters of the planning horizon. However, (i) the October 2014 revisions to the Capital Plan and Stress Test Rules provided an exception to this assumption for issuances related to employee compensation, and (ii) assumptions relating to business plan changes require large BHCs to project the effects of any planned mergers or acquisitions in balance sheet projections. To better align the capital action assumptions with these provisions, the Proposed Rule would (x) make a technical change to require a firm to assume that it pays dividends equal to the quarterly average dollar amount of common stock dividends that the company paid in the previous year on any issuance of stock related to expensed employee compensation, and (y) permit a large BHC to assume that it issues capital associated with funding a planned acquisition to the extent it is required to include an assumption in its balance sheet projections regarding such planned acquisition.
  • Elimination of fixed dividend payment assumptions: The Proposed Rule would eliminate the fixed dividend payment assumptions for BHCs with more than $10 billion but less than $50 billion of consolidated assets and savings and loan holding companies (“SLHCs”) with total consolidated assets of more than $10 billion. The DFAST Stress Test Rules currently require subject BHCs and SLHCs to make the same capital action assumptions in their stress tests that apply to large BHCs by assuming that they (i) maintain their common stock dividend at a steady rate over the planning horizon, (ii) continue payments on other regulatory capital instruments at their stated dividend rate, and (iii) do not repurchase or issue shares during each of the second through ninth quarters of the planning horizon. The Proposed Rule would eliminate the requirement to incorporate fixed assumptions regarding dividends in stress tests for BHCs with total consolidated assets of more than $10 billion but less than $50 billion and SLHCs with total consolidated assets of more than $10 billion, instead requiring these banking organizations to incorporate their own dividend payment assumptions consistent with internal capital needs and projections. However, the Proposed Rule would maintain the required assumption that there will be no repurchases, redemptions or issuances of regulatory capital instruments.

Notably, the NPR states that the FRB does not anticipate any further changes that would impact the 2016 capital plan and stress test cycle beyond those outlined therein. As such, capital buffers (including the GSIB capital surcharge buffer)5 will not be incorporated into CCAR for the 2016 cycle. The FRB continues to consider “a broad range of issues” related to the capital plan and stress testing framework — including their interaction with other elements of the capital rules—and it would propose any further changes in a separate rulemaking that would take effect no earlier than the 2017 cycle. In addition, in his opening remarks on the final rule implementing the GSIB capital surcharge buffer on July 20, Governor Tarullo indicated that the FRB “will need to consider whether and, if so, how to incorporate the surcharges into the post-stress minimum capital levels required in [CCAR].”

Furthermore, the Proposed Rule would also delay, for one stress test cycle, the company-run stress test requirement for SLHCs with total consolidated assets of more than $10 billion, making the requirement applicable for the first time beginning on January 1, 2017. This change is being proposed to reinstate the originally intended transition period for these SLHCs in light of the October 2014 revisions to the DFAST Stress Test Rules that effectively shortened the transition period from the original two years to one year.

Finally, the NPR also includes technical amendments to the Capital Plan and DFAST Stress Test Rules meant to incorporate changes related to other rulemakings, most notably by (i) amending the definition of minimum regulatory capital ratios to replace references to the risk-based capital rules in 12 C.F.R. part 225 (which are no longer operative as of January 1, 2015) with references to the revised risk-based capital rules in 12 C.F.R. part 217, and (ii) to incorporate the deduction of aggregate investments in covered funds from tier 1 capital as required under the Volcker Rule,6 which is not currently reflected in the regulatory text of 12 C.F.R. part 217.

Comments on the Proposed Rule must be received by the FRB on or before September 24, 2015.