On Wednesday, the Federal Reserve approved the final rule to amend the capital plan and stress testing rules effective 2016. Notably, the annual stress test helps reaffirm that the U.S. banking giants are adequately capitalized to survive under a tremendously difficult economic scenario.
Amendments to Existing Capital Plan and Stress testing rules
The final rule amends some capital action assumptions in the stress test rules, which are mandatory for banks exceeding $10 billion but less than $50 billion in total consolidated assets and savings and loan holding companies with total assets of more than $10 billion. Moreover, the company-run stress test requirements for savings and loan holding companies are also being delayed till Jan 1, 2017.
Per the final rule, banks will be given more time to include certain regulatory requirements into their capital plan and stress-testing structure. Such requirements include the supplementary leverage ratio, which is being included in the framework in 2017.
Further, for stress testing rules, firms will continue using the generally applicable risk-based capital framework. However, use of the advanced approaches risk-based capital framework mandatory for firms with minimum $250 billion in total consolidated assets or $10 billion in on-balance sheet foreign exposures will be deferred indefinitely. Yet, application of advanced approaches framework for the regulatory capital ratios will continue as before for such firms.
Additionally, the common equity tier 1 capital requirement by the banks for clearing the stress test under Fed’s revised regulatory capital rules will be fully phased-in over the nine-quarter planning horizon of the 2016 capital plan and stress testing cycles. Notably, the modified rule will require banks to hold more capital in comparison to that needed under the existing capital rules for maintaining the tier 1 common ratio as per requirement. However, tier 1 common capital requirement will be null after the new rules become effective.
Further review of the rules will be continued by the Fed. However, any amendments to the same will be effective through a separate proposal not before 2017.
Root of the Stress Test
Currently authorized under the Dodd-Frank financial-services law, the stress tests were first introduced after the 2008 financial crisis. During this economic downturn, financial stalwarts like Lehman Brothers collapsed and several other big banks were on the verge of a collapse. Such a situation compelled the U.S. government to infuse billions of dollars into credit markets and safeguard the entire financial system from a collapse.
Conclusion
Banks including Wall Street biggies – Wells Fargo & Company WFC, Citigroup Inc. C, Bank of America Corporation BAC and JPMorgan Chase & Co. JPM will have to undergo the Fed’s stress test once every year. This would help build up the weak capital levels of banks, which are always a threat to the economy.
Though economic uncertainty still lingers, banks are actively responding to every legal and regulatory pressure. In fact, this has positioned the banks well to encounter impending challenges. As the sector is undergoing a radical structural change, it is expected to witness headwinds in the near to mid term. However, entering the new capital regime will significantly improve the industry’s long-term stability and security.
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