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FRB Vice Chair Proposes Modifications to Stress Testing Program Proposal

Federal Reserve Board ("FRB") Vice Chair for Supervision Randal K. Quarles proposed modifying the FRB's large stress testing regime in response to industry feedback.

As previously covered, the FRB requested comments on a proposal that would revise the capital and stress test rules for bank-holding companies with more than $50 billion in total consolidated assets. The original proposal was intended to establish a "stress capital buffer" ("SCB") requirement for large banking organizations, with the goal of producing a "tailored and risk-sensitive capital regime."

In response to industry concerns, Mr. Quarles recommended removing certain redundant elements and introducing "two new co-equal options." First, he indicated that the stress leverage buffer requirement could be removed. Instead, the FRB would continue using existing leverage ratios, which provide a "sufficient backstop to the risk-based capital requirements." Additionally, he expressed support for removing the requirement of pre-funding four quarters of planned dividends. According to Mr. Quarles, this requirement is both "needless[ly] redundant" and in conflict with existing mechanics.

To reduce pro-cyclicality, Mr. Quarles proposed two alternative measures. First, Mr. Quarles suggested raising the U.S. countercyclical capital buffer ("CCyB") to a higher baseline level during normal times. Second, Mr. Quarles proposed raising the SCB floor from the fixed 2.5 percent of risk-weighted assets to a higher level. In comparing the two alternatives, Mr. Quarles stated, raising the SCB floor is a simpler, more transparent, and more predictable solution. However, he noted that the higher fixed floor option would more greatly affect firms with losses closer to the existing 2.5 percent floor, and that it is less direct than the more actively managed CCyB option.

Mr. Quarles expressed the hope that the SCB framework would be finalized for the 2020 stress tests.

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