Fed Proposes to Amend Stress Capital Buffer Requirement

The Federal Reserve Board ("Fed") proposed "[to] amend the calculation of the Board's stress capital buffer requirement." 

The Fed explained that the stress test enables the Board "to assess whether [covered financial institutions] have sufficient capital to absorb potential losses and continue lending under a set of hypothetical severely adverse conditions." The Fed said that an institution's supervisory stress test results can vary materially due to "changes in (1) firms’ balance sheet size and risk or projected income and expenses, (2) economic conditions since the previous stress test, (3) the severely adverse scenario used in the supervisory stress test, and (4) the supervisory models used in the supervisory stress test." The Fed issued the rulemaking based on concern that this variation may "impact the provision of banking services," including how it may influence "decision-making regarding investment and expansion, create challenges in long-term capital planning, and impact the supply of credit to households and businesses."  

In the rulemaking, the Fed proposed to: (i) average the results of the supervisory stress test over two years to "reduce volatility in the stress capital buffer requirement' and (ii) to modify and add elements to required data collection reports ("FR Y-14A/Q/M") to "improve the accuracy" of stress capital calculations and to eliminate items "no longer needed to conduct the supervisory stress test." The Fed said that these changes are intended to preserve flexibility and "are not designed to materially affect overall capital requirements." The Fed also proposed to extend the effective date of those requirements from October 1 to January 1, giving firms three additional months to comply. Public comments are due 60 days after the rule is published in the Federal Register.

Fed Governor Michael S. Barr opposed the proposed changes warning they risk "turning stress testing into an ossified exercise" that offers "false comfort." He argued that the proposal invites a "one-way ratchet" that would weaken the financial system's resilience in a downturn as banks can, among other things, challenge capital-raising elements while ignoring underpriced risks and game outcomes by reshaping balance sheets.

Fed Governor Adriana D. Kugler supported the proposal's aim to "reduce volatility" and extend the compliance timeframe. However, she expressed concern that equal weighting of two years of data introduces an 18-month lag, reducing sensitivity to current economic and firm-specific risks. She welcomed public comment on whether the most recent year should be "given more weight" to address this drawback.