On Feb. 18, 2014, the Federal Reserve Board (FRB) approved final rules requiring enhanced prudential standards for bank holding companies (BHCs) that exceed certain total asset thresholds. Section 165(i)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) provides that “financial companies that have total consolidated assets of more than $10 billion and are regulated by a primary federal financial regulatory agency shall conduct annual stress tests.” The final rule implements the Dodd-Frank requirement to conduct annual stress tests and establishes the definition of a stress test, methodologies for conducting stress tests, and stress test reporting and disclosure requirements. In addition, the final rules require publicly traded BHCs with total consolidated assets of $10 billion or more to establish enterprise risk committees.
BHCs with more than $10 billion in total consolidated assets and less than $50 billion in total consolidated assets must conduct a company-run stress test by March 31 of each calendar year using financial statement data as of Sept. 30 of the preceding calendar year. BHCs that meet the asset threshold must conduct a stress test by March 31, 2014, for the initial stress test cycle that commenced on Oct. 1, 2013. A stress test is a process to assess the potential impact of scenarios on the consolidated earnings, losses and capital of a BHC over the planning horizon, taking into account current conditions, risks, exposures, strategies and activities. BHCs must use the scenarios provided by the FRB as well as any additional scenarios or components required by the FRB. For each scenario, BHCs must estimate the following:
- Potential impact on capital.
- Assumptions regarding capital actions.
- Controls and oversight of stress-testing processes.
BHCs that meet the asset threshold must report stress test results to the FRB by March 31 of each calendar year. The report must include, for each of the scenarios required by the FRB, a description of the risks analyzed in the stress test; a description of the methodologies used in the stress test; and estimates of aggregate losses, pre-provision net revenues, provisions for loan and lease losses, net income, and regulatory capital ratios for the planning horizon, as well as an explanation of the most significant causes for any changes in regulatory capital ratios. BHCs that meet the asset threshold must make an initial public disclosure of the stress test results beginning with the next annual stress test cycle that commences on Oct. 1, 2014. A summary of stress test results may be disclosed on the BHC’s website or “any other forum that is readily accessible to the public.”
Additionally, publicly traded BHCs with more than $10 billion in total consolidated assets as of June 30, 2014, must establish and maintain an enterprise risk committee before July 1, 2015. The risk committee must approve and periodically review the BHC’s risk-management framework. The BHC’s risk- management framework must consist of policies and procedures establishing risk-management governance and risk-control infrastructure for its operations. Risk-management policies and procedures must describe the processes and systems for implementing and monitoring compliance, including the following:
- Processes and systems for identifying and reporting current risks and risk-management deficiencies as well as ensuring the effective and timely implementation of actions to address emerging risks and risk-management deficiencies for its operations.
- Processes and systems for establishing managerial and employee responsibility for risk management.
- Processes and systems for ensuring the independence of the risk-management function.
- Processes and systems to integrate risk management and associated controls with management goals and its compensation structure for its operations.
The risk committee must have a formal, written charter that is approved by the BHC’s board of directors, meet at least quarterly, and fully document and maintain records of its proceedings, including risk-management decisions. Furthermore, a risk committee must include at least one member who has experience in identifying, assessing and managing risk exposures of large, complex firms, and be chaired by a director who satisfies the following requirements:
- The director is not an officer or employee of the BHC and has not been an officer or employee of the BHC during the previous three years.
- The director is not a member of the immediate family of an officer or employee of the BHC during the previous three years.
- The director is an independent director.
Publicly traded BHCs with total consolidated assets of $10 billion of more should review their risk-management framework and enterprise risk committee requirements to confirm that each is consistent with the final rules, as well as consider the appropriate public disclosure of stress test results to investors.