Why it matters

Capital planning and stress tests for bank holding companies and other institutions with assets over $10 billion have been finalized by the Federal Reserve Board of Governors. For bank holding companies with more than $10 billion but less than $50 billion in total consolidated assets and savings and loan holding companies with consolidated assets of more than $10 billion, the final rule modifies certain capital assumptions in the stress test rules and delays the application of the company-run stress test requirements to savings and loan holding companies until January 1, 2017. For bank holding companies that have total consolidated assets of $50 billion or more the final rule delays the use of the supplementary leverage ratio for one year and indefinitely defers the use of the advanced risk-based capital framework in the capital plan and stress test rules. The delay was proposed in July and is intended to "allow banking organizations time to develop the systems necessary to project the supplementary leverage ratio under stressed conditions," the Fed explained in a statement. Other changes in the final rule include the elimination of the tier 1 common capital ratio requirement for the largest banks replaced by the Board's minimum common equity tier 1 capital requirement. As banks prepare to ensure compliance with the final rule, the Fed warned it may not be done. "[T]he Board continues to review a broad range of issues related to its capital planning and stress testing rules," the agency cautioned, adding that any modifications based on its review would be undertaken through a separate rulemaking and take effect no later than the 2017 cycle.

Detailed discussion

Included in the 2010 passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act were provisions mandating stress tests for the country's financial institutions. After issuing preliminary rules, the Federal Reserve Board of Governors published its final rules with an effective date of January 1, 2016.

The stress test mandate is meant to ensure that banks have sufficient capital and risk management practices in place in the event of an economic downturn, the Fed said. Pursuant to the final rule, banks with more than $50 billion in consolidated assets must calculate a supplementary leverage ratio, or the ratio of a bank's core costs to its total leverage exposure.

However, the Fed granted an extra year for covered entities to get up to speed on the new requirements, promising that enforcement will not begin until 2017. The final rule also pushed back use of the advanced approaches risk-based capital framework found in the stress test rules, under which banks would use an internal rating system, among other measurements, to calculate risk-based capital requirements for credit and operational risk. With that approach delayed indefinitely, banks should continue to use the generally applicable risk-based capital framework, the Board said.

In another change, the Federal Reserve eliminated another mandate for the biggest banks, the tier 1 common capital ratio requirement, which set parameters for how much capital was necessary to have on hand for the bank to absorb loss during different types of stress scenarios. Instead, the Board said the common equity tier 1 capital requirement will be fully phased in over the course of 2016 capital plan and stress testing cycles. "Generally, this ratio will require firms to hold more regulatory capital than the tier 1 common ratio," the Fed noted.

To read the final rule, click here.