FRB Issues Capital Requirements for Large Banks
Commentary by Sebastian Souchet
The Federal Reserve Board published its final individual capital requirements for all large banks, effective October 1, 2024.
According to the FRB, large bank capital requirements are informed by the Board's stress test results, which provide a risk-sensitive and forward-looking assessment of capital needs. (See previous coverage.) The FRB showed each bank's common equity tier 1 capital requirement, which is made up of several components, including:
- the minimum capital requirement, which is the same for each bank and is 4.5 percent;
- the stress capital buffer requirement, which is based in part on the stress test results and is at least 2.5 percent; and
- if applicable, a capital surcharge for the largest and most complex banks, which is updated in the first quarter of each year to account for the overall systemic risk of each of these banks.
The FRB said it lowered the extra capital level required of a bank, after the bank asked the FRB to reconsider its finding. The bank now must hold a "stress capital buffer" of 6.2 percent, down from the 6.4 percent suggested in the test. The FRB agreed to the change after receiving additional information from the bank.
Commentary
A notable part of the FRB's announcement is its decision to modify a G-SIB's Stress Capital Buffer ("SCB") requirement after the firm requested reconsideration.
In its response, the FRB highlighted four arguments the firm made: (i) "recent expenses associated with impairment of goodwill and other intangibles from business divestitures should not influence pre-provision net revenue ("PPNR") projections of non-interest expense"; (ii) "recent expenses related to losses associated with the write-down of consolidated investment entities should not influence PPNR projections"; (iii) "revenue components of the PPNR model should be less sensitive to the firm's performance in the most recent time periods"; and (iv) the FRB should modify its practice of "modeling noninterest expenses based on total assets because increases in total assets are not a reliable predictor of changes in noninterest expense" (pp. 5-6).
With respect to (i) and (ii) above, the FRB concluded that while the stress test models "operated as intended, there was an inappropriate treatment applied to certain input data" (p. 6). Thus, the FRB agreed to adjust the firm's SCB requirement because of the "non-recurring nature" of the expenses involved (p. 6). However, the FRB did not agree with the firm's arguments in (iii) and (iv) above. Rather, the FRB determined in each instance that the PPNR model used in the stress test functioned as intended, and that no errors were found in the relevant application of the model (pp. 6-7).
Notably, the FRB acknowledged, in connection with the firm's argument regarding the sensitivity of the revenue components of the PPNR model to a firm's recent performance, that providing firms with their nine-quarter CET1 projections would "improve the transparency of the stress testing program," and thus the FRB directed its staff to disclose such projections when notifying each firm of its preliminary SCB requirement in the future (p. 7). Further, the FRB directed its staff to "explore possible refinements to the PPNR model components" to address the possibility of weaknesses in the stress test model with respect to the factors highlighted by the firm.
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The Board of Governors of the Federal Reserve System released the results of its annual bank stress test. The stress test results demonstrated that all 31 big banks tested had "sufficient capital to absorb nearly $685 billion in losses and continue lending to households and businesses under stressful conditions" while remaining "well above minimum capital requirements."
