The U.S. Federal Reserve Board issued a final rule Tuesday requiring the biggest U.S. banks to submit annual capital plans to the regulator, and outlined its plans to stress test the largest banks.
Under the final rule, the Fed will evaluate large banks’ capital adequacy, internal capital adequacy assessment processes, and their plans to make capital distributions, such as dividend payments or stock repurchases. The Fed will only approve dividend increases or other capital distributions for companies whose capital plans are approved and are able to demonstrate sufficient financial strength to operate under stressed macroeconomic and financial market scenarios, even after making the desired capital distributions.
The aim of the annual capital plans is to ensure that institutions have robust, forward-looking capital planning processes that account for their unique risks, and to help ensure that institutions have sufficient capital to continue operations throughout times of economic and financial stress, the Fed says. Institutions will be expected to have credible plans that show they have sufficient capital so that they can continue to lend, even under adverse conditions, and are well prepared to meet regulatory capital standards.
In addition to issuing the final rule, the Fed issued instructions outlining the information it is seeking from the firms, and the analysis it will do, for its stress testing program in 2012. There are two sets of instructions: one for the 19 firms that participated in the Fed’s stress tests earlier this year, and the other for 12 additional firms with at least $50 billion in assets that have not previously participated in a stress test exercise. The level of detail and analysis expected in each institution’s capital plan will vary based on the company’s size, complexity, risk profile, and scope of operations.
The instructions include a stress scenario that will be used by all of the firms and the Fed to analyze firms’ capital needs to withstand such a scenario. The scenario is designed to represent an outcome that, while unlikely, may occur if the U.S economy were to experience a deep recession while at the same time economic activity in other major economies were also to contract significantly.
In addition to the macroeconomic scenario, the six largest firms will be required to estimate potential losses stemming from a hypothetical global market shock. The global market shock will be based on market price movements seen during the second half of 2008, which was a time of significant volatility, with adjustments made to incorporate potential sharp market price movements in European sovereign and financial sectors.
The Fed says it plans to publish the results of the supervisory stress tests for each of the 19 institutions, including the results of the market shock for the six institutions with large trading operations.