Federal Reserve Board Governor Tarullo Indicates an Increase in Large Bank Holding Companies’ Post-Stress Minimum Capital Ratios Is Likely

c. Any material change in the minimum is likely to be of particular significance because many banks have indicated that the stressed capital requirements are the most constraining of all the capital requirements. Governor Tarullo commented:

We need to think further about enhancing the macroprudential element of the stress test, which means [considering the] impact not just on the bank of a particular loss but on the financial system .… Although we haven’t decided exactly how to do that, I think there’s a pretty good chance … that at the end of the day, whether through the incorporation of some or all of the capital surcharge as a post- stress minimum, or some other mechanisms, such as ... more emphasis on shared counterparties, that there will be some net increase in the post-stress minimum capital requirements.1

As reflected in the highlighted language, Governor Tarullo suggested two possible approaches to increased post-stress minimum capital ratios—(i) one requiring that some or all of the capital surcharge imposed on the eight U.S. globally systemically important bank holding companies, or “G-SIBs”, be added to the post-stress minimum requirements for those bank holding companies and (ii) the other based on interconnectedness by devising an incremental requirement or surcharge based on “shared counterparties”—but left open the possibility of other approaches. Although the G-SIB surcharge approach suggests a focus on those bank holding companies, his comments did not limit possible increased post-stress capital requirements to G-SIBs.

Under the Federal Reserve’s capital plan rule,2 bank holding companies with $50 billion or more in total consolidated assets are required to file annual capital plans with the Federal Reserve showing their capital ratios over a nine-quarter planning horizon taking into account all planned capital actions (that is, both capital distributions such as dividends and share repurchases and contemplated issuances of capital securities).3 The next capital plans are due to be filed in April 2016 and will cover a planning horizon that commences on January 1, 2016 and ends on March 31, 2018.

The capital plan rule currently requires that capital plans show capital ratios as of each quarter-end during the planning horizon, and at the end of the nine quarters, based on three scenarios—base, adverse and severely adverse. The Federal Reserve may object to a covered bank holding company’s capital plan, and prohibit or limit its planned capital distributions, if the Federal Reserve determines, after applying its own undisclosed models to the plan and related data as part of the Federal Reserve’s Comprehensive Capital Assessment Review, or “CCAR”, that the bank holding company has not demonstrated an ability to maintain capital above each “minimum required regulatory capital ratio” under both base and stress scenarios throughout the planning horizon.4   The capital plan rule defines the term “minimum regulatory

capital ratio” as any minimum regulatory capital ratio that the Federal Reserve may require “by regulation or order.”5 As a practical matter, bank holding companies must, in their own plans, demonstrate projected capital meaningfully above the regulatory minimum requirements because the Federal Reserve’s models frequently produce projected capital ratios well below the ratios produced by bank holding companies’ own models and calculations.

Governor Tarullo did not address whether the Federal Reserve would move ahead with any increase in post-stress minimum ratios only after a rulemaking involving notice and the opportunity for comment. Given the importance of the issue and the definition of the term “minimum regulatory capital ratio” in the capital plan rule, it would seemingly be appropriate for the Federal Reserve to implement any proposed change only through a rulemaking or order subject to notice and comment. Such an administrative process should also enable an evaluation of the so-called “interconnectedness” issue, which the Federal Reserve also indicated it will address in a reissuance of a single counterparty exposure limitation.

In connection with the proposal in 20146 and final adoption earlier this year7 of the G-SIB surcharge,8 the Federal Reserve raised the possibility of including some or all of the G-SIB surcharge, as well as potentially other existing capital buffers such as the capital conservation buffer, as a component of minimum required regulatory capital ratios for purposes of the capital plan rule but deferred taking final action until after the end of the 2016 capital planning cycle. Governor Tarullo’s comments in his recent Bloomberg TV interview indicate that this is now under active Federal Reserve consideration.