The Fed Increases Large Banks’ Capital Requirements

The Fed Increases Large Banks’ Capital Requirements

Yesterday, the Federal Reserve released the results of the 2018 Comprehensive Capital Analysis and Review (CCAR). As described in previous TCH’s posts, the 2018 results were crucially driven by the increased severity in this year’s hypothetical set of stressful economic and market conditions developed by the Federal Reserve. As a result, banks’ capital requirements have increased by approximately one percentage point based on our analysis of this year’s stress results. In this blog post, we describe how that happened and discuss some of the current challenges banks face regarding the integration of the regulatory capital rules with the CCAR and stress testing rules through the stress buffer requirements proposed by the Federal Reserve. In summary:
Excess capital (i.e., the maximum amount of capital a bank can return to its shareholders without violating any capital requirement) declined by $91 billion, driven by the extreme severity of the Fed’s stress scenario in this year’s exercise. In previous research, we demonstrated that excess bank capital is an important determinant of economic growth;
The resulting increase in capital requirements is likely to increase the cost of bank loans, especially to cyclically sensitive sectors, including loans to corporations that are not considered “investment grade”, small businesses, and households with less-than-pristine credit histories;
This year’s results illustrate that capital requirements in the United States are highly volatile from year to year and that the volatility will be magnified by the integration of the regulatory capital rules with the CCAR and stress testing rules under the stress buffer requirements proposal; and
Lastly, the potential removal of the qualitative assessment of CCAR (as speculated by a recent Wall Street Journal article) would not reduce banks’ incentives to invest in passing the stress tests. If anything, the importance of stress testing is likely to increase as a result of the proposed stress buffer requirements and the proposed rating system for large financial institutions.

Francisco Covas, Brett Waxman, and Robert Lindgren

The Clearing House

June 29, 2018

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