Published on June 23, 2016 by Dr. Paul Chen
The Federal Reserve (Fed) will announce the results of its annual CCAR results for 2016 on Thursday, June 23, 2016, which, as usual, is likely to spark a wave of discussions in the banking industry.
The Comprehensive Capital Analysis and Review (CCAR) is an annual stress test conducted by the Fed and is an intensive assessment of the capital adequacy of large US bank holding companies (BHCs) and the practices these financial institutions use to determine capital requirements. In its submission instructions, the Board has described three supervisory scenarios – baseline, adverse, and severely adverse – that the participating BHCs must use to conduct their stress tests and that certain large BHCs must use to estimate projected revenues, losses, reserves, and pro-forma capital levels as part of its capital plan submission. For 2016, more big banks are required to participate in the CCAR exercise than ever before; this year, 33 banks will be awaiting their CCAR results compared to 19 BHCs in 2009-13.
While the submission instructions are largely in line with prior published guidance, specific features of the 2016 CCAR instructions are worthy of attention. These include the introduction of a period of negative short-term interest rates in the severely adverse scenario, and emphasis on the differentiation of requirements between larger and smaller firms, documented under separate supervisory letters SR 15-18 and SR 15-19.
Just under half of the 33 BHCs participating in this year’s test are either subject to the Large Institution Supervision Coordinating Committee (LISCC) framework (a LISCC firm) or are deemed to be Large and Complex firms, defined as firms with (a) total consolidated assets of $250 billion or more, or (b) consolidated total on-balance sheet foreign exposure of $10 billion or more. The remaining CCAR firms –those that are not subject to the LISCC framework or do not meet the threshold for Large and Complex Firms – are simply called Large and Non-complex.
For the 2016 CCAR submission, the Fed has higher expectations and more stringent requirements for LISCC and Large and Complex firms compared to Large and Non-complex counterparts throughout the capital planning process. For example, LISCC firms and Large and Complex firms will be expected to:
Emphasize the usage of quantitative models to project losses, balance sheet, and pre-provision net revenue, with added scrutiny on the assumptions used therein
Complete conceptual soundness reviews of all models prior to implementation
Increase the use of benchmark modeling and model validation in capital planning
Expand utilization and documentation of standardized RWA projection calculations
Enhance standards and expectations related to internal auditing standards and practices, development of stress scenarios independent to the Fed’s requirements, and quarterly review of the capital planning process with senior management
Passing the test will demonstrate the BHCs’ capital adequacy in sustaining a severely adverse economic shock and their ability to continue operating without interruptions to customer services. Furthermore, compliant banks will have the green light to execute their planned capital distribution strategies, including share buybacks and dividend distributions. Top performers may even see improved stock performance – in a recent research report published by Merrill Lynch, the team noted that in the last four CCAR results from 2012, top-performing groups outperformed the bottom range by an average of 3.8% in the month following CCAR results.
Failing CCAR could result in significant consequences for affected banks. According to the Wall Street Journal, Bank of America and Citigroup could have theoretically returned a combined total of $24 billion to shareholders had they passed their CCAR exercises over the last three years, assuming similar levels of dividends and stock repurchases as Wells Fargo. BHCs that fail the test will not only be prevented from carrying out planned capital distributions without Fed approval, but will also be required to undergo dramatic changes to their existing business strategies, including increased investments in resources and infrastructure, and possibly even organizational restructuring.
Regardless of individual CCAR results, one definite impact from the last few years of stress testing has been banks’ growing efforts and increased resources to address and incorporate the Fed’s feedback on their CCAR process and practices. Even for those banks that have passed, the Fed issues detailed lists of “matters requiring attention” and “matters requiring immediate attention” that need to be addressed and fixed ahead of the next year’s CCAR submission. These incremental tasks, which are in addition to banks’ routine business operations, have created an added burden for large financial institutions and, in many cases, have resulted in temporary staffing shortage, a trend that is likely to persist until the CCAR process stabilizes and becomes second nature to all financial institutions in the US banking system.
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