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Federal Reserve Proposes to Amend Capital Plan and Stress Test Rules

On Friday, July 17, 2015, the Federal Reserve released a proposal (the “Proposal”) to amend the capital plan and stress test rules for large bank holding companies and certain banking organizations with total consolidated assets of more than $10 billion.  The proposed changes would take effect beginning with the 2016 capital planning and stress testing cycles, the submissions for which are due April 5, 2016 based on a planning horizon beginning with actual capital levels as of December 31, 2015.  The Proposal would have different effects depending on the size and complexity of the affected banking organizations.

Proposed Amendments Applicable to All Subject Banking Organizations

For all banking organizations subject to the capital plan and stress test rules, the Proposal would:

  • Remove the capital measure known as “Tier 1 Common,” a measure based on the Basel I capital rules, and the associated risk-based capital ratio, in order to make the capital plan and stress test rules consistent with the non-stressed regulatory capital requirements, which as of January 1, 2015 are based on Basel III measures for all subject banking organizations. The Federal Reserve noted that, under the severely adverse stress scenario, the Common Equity Tier 1 (“CET1”) ratio generally is expected to be more binding than the legacy Tier 1 Common ratio because of deductions from and adjustments to CET1;
  • Remove references to the Basel I capital rules; and
  • Amend the relevant definitions of regulatory capital ratios in the capital plan and stress test rules to incorporate the deductions from Tier 1 capital for aggregate investments in covered funds required by the Volcker Rule. However, the banking agencies still have not proposed any rules—as they said they would do in the preamble to the Volcker Rule final regulations—reconciling the U.S. Basel III capital rules relating to deductions from CET1 capital and the Volcker Rule deductions from Tier 1 capital.  To the extent a bank holding company already deducts an investment in a covered fund from CET1 capital under the U.S. Basel III capital rules, presumably the bank holding company would not have to make a second deduction to comply with the Volcker Rule deduction from Tier 1 capital.

Proposed Amendments Applicable to Large Banking Organizations

For bank holding companies with total consolidated assets of $50 billion or more, U.S. intermediate holding companies of foreign banking organizations, and nonbank systemically important financial institutions that are subject to capital planning and stress testing requirements (collectively, “large banking organizations”), the Proposal would:

  • Require a large banking organization, in line with the Federal Reserve’s October 2014 revisions to the capital plan and stress test rules, to reflect in its capital action assumptions under the company-run stress test rules dividends associated with issuances related to expensed employee compensation; and
  • Require a large banking organization, in line with the required assumptions relating to business plan changes, to assume that it issues capital associated with funding a planned acquisition to the extent that it is required to include the acquisition in its balance sheet projections.

Proposed Amendments Applicable to Advanced Approaches Banking Organizations

For bank holding companies that use the advanced approaches to calculate their minimum regulatory capital requirements, the Proposal would:

  • Defer the incorporation of the supplementary leverage ratio in the capital plan stress test rules until the capital planning cycle beginning January 1, 2017; and
  • Indefinitely defer the use of the advanced approaches for calculating risk-based capital requirements for purposes of the capital plan and stress test rules. We note that, while this proposal would not affect the use of the advanced approaches for purposes of maintaining minimum capital ratios and related capital buffers, it nevertheless raises questions about the future of the advanced approaches.

Proposed Amendments Applicable to Mid-sized Bank Holding Companies and All Subject Savings and Loan Holding Companies

For bank holding companies with total consolidated assets greater than or equal to $10 billion but less than $50 billion and all savings and loan holding companies (“SLHCs”) subject to the stress test rules, the Proposal would:

  • Eliminate the requirement to incorporate fixed assumptions regarding dividends in their company-run stress tests, requiring them instead to incorporate the company’s own dividend assumptions. Among other things, this change would allow bank holding companies with banks subject to dividend payment restrictions to reflect those restrictions in the bank holding company’s dividend payment assumptions; and
  • Delay the company-run stress testing requirements for subject SLHCs until the stress testing cycle beginning January 1, 2017. SLHCs with at least $50 billion in total consolidated assets would be required to report results by April 5, 2017.  SLHCs with total consolidated assets of less than $50 billion but more than $10 billion would be required to report results by July 31, 2017.
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