Federal Reserve Finalizes “Stress Capital Buffer”

Risk-based capital requirements for GSIBs increase, but broad relief from post-stress leverage requirements for all CCAR firms

March 16, 2020

On March 4, the Federal Reserve finalized a significant integration of its stress testing regime with its ongoing supervisory capital requirements, by introducing a new “stress capital buffer” requirement for firms subject to the Federal Reserve’s CCAR supervisory stress tests.

An institution-specific stress capital buffer will be determined for each CCAR firm as part of the 2020 CCAR exercise and is intended to take effect October 1, 2020.  However, given the uncertainty and stress in the market caused by COVID 19 mitigation measures, it remains to be seen whether the Federal Reserve could modify the implementation timeline. 

The Federal Reserve’s supervisory stress test regime is, and almost certainly will continue to be, the binding capital constraint on most CCAR firms.  The Federal Reserve touts the stress capital buffer and related changes as “simplifying” and part of its “recent efforts to improve the efficiency and risk-sensitivity of its regulations”. 

One key simplification is the elimination of the “pass/fail” quantitative assessment. Accordingly, CCAR now becomes primarily an exercise in calculating a CCAR firm’s stress capital buffer.  Beginning October 1, 2020, the stress capital buffer will become a day-to-day ongoing capital requirement in order for CCAR firms to avoid restrictions on capital distributions. This ends the prior CCAR regime’s single-point-in-time approach to evaluating capital plans, which allowed CCAR firms’ pre-stress-test capital to decrease (within bounds) in between the CCAR supervisory stress tests.

The final rule generally adopts the proposal released in April 2018, but includes several welcome modifications.  Significantly, the Federal Reserve formally discarded the proposed “stress leverage buffer” that would have applied to the Tier 1 leverage ratio and eliminated post-stress leverage capital requirements.  CCAR firms no longer must maintain Tier 1 capital above the minimum Tier 1 leverage ratio or minimum supplementary leverage ratio throughout the nine quarters of the hypothetical stress scenario in order to avoid restrictions on their capital distributions.  But one anticipated modification to eliminate the requirement to “prefund” one year of common stock dividends was not incorporated into the final rule, despite Vice Chair Quarles’ stated support in recent remarks.  Other modifications, such as permitting CCAR firms not to incorporate material business plan changes into the calculation of their stress capital buffer and elimination of the pre-approval requirement for capital distributions above a CCAR firm’s original planned distributions, will provide more flexibility to make distributions.

Please click here to read the full alert memorandum.

(Republished in the Columbia Law School Blue Sky Blog, March 18, 2020.)