Tuesday night, the Federal Reserve announced its proposed changes to its annual stress test procedures – and they’re not going to benefit the big banks.
The new proposed changes would lead to slightly higher capital requirements for some of the largest and most complex groups, but would give relief to some smaller lenders, according to an article by Sam Fleming and Alistair Gray for the Financial Times.
Currently, banks must hold a fixed buffer equivalent to 2.5% of risk-weighted assets, above and beyond minimum levels. However, this would now be replaced with a new buffer with a floor of 2.5%, but that could go higher, based on how much capital a bank loses in the hypothetical stress test, according to an article by Aaron Back for The Wall Street Journal.
From the WSJ article:
Thus, a bank with a common equity tier 1 capital ratio of 9% that falls to 6% under the Fed’s most severe scenario would have to hold an extra 3 percentage points of capital, not 2.5 points as under the existing system. The net effect is to raise capital requirements on banks that see more volatile results during a crisis.
Nomura’s Steven Chubak estimates Goldman Sachs and Morgan Stanley might each have to retain additional capital thanks to the changes. However, more commercially-focused banks like Citigroup, Bank of America and JPMorgan Chase should be less affected.
But smaller lenders, or those not considered “systemically important” would see a significant decrease in their capital requirements – between $10 billion and $45 billion in aggregate, according to the Financial Times article.
However, there are still some changes that will benefit U.S. banks. From the WSJ article:
The stress tests will no longer assume that banks maintain their planned dividends and buybacks throughout a crisis, an unrealistic assumption that bank executives have long grumbled about. The “soft cap” on dividend payout ratios will also be scrapped, which should allow bank dividend yields to go higher over time.
Large banks would also now be required to meet 14 capital requirements, rather than the current 24.
In 2017, for the second year in a row, all of the nation’s largest financial institutions passed their stress tests, meaning each company has enough capital on hand to survive a “severe recession.”