Fed FAQ Re Fin Institution Stress Tests

Author: Market News International | Category: News

WASHINGTON (MNI) – The following are several answers to what the
Federal Reserve said are frequently asked questions about the financial
institution stress tests announced Tuesday:

Comprehensive Capital Analysis and Review for 2012
Frequently Asked Questions
November 22, 2011

1. What is the 2012 Comprehensive Capital Analysis and Review (CCAR 2012)?

Capital is central to a bank holding company’s ability to absorb
unexpected losses and continue to lend to creditworthy businesses and
consumers. The Federal Reserve expects large, complex bank holding
companies to hold sufficient capital to maintain access to funding, to
continue to serve as credit intermediaries, to meet their obligations to
creditors and counterparties, and to continue operations, even in an
adverse environment. It is with this in mind that the Federal Reserve on
Tuesday adopted the capital plans rule for bank holding companies (BHCs)
with assets greater than $50 billion. The capital plans rule requires
these BHCs to develop and submit a capital plan to the Federal Reserve
on an annual basis and to request prior approval from the Federal
Reserve under certain circumstances before making a capital
distribution.

CCAR 2012 is the supervisory exercise that is being conducted to
facilitate supervisory assessments of the BHCs’ internal capital
planning processes, capital adequacy, and proposed capital
distributions. The CCAR involves forward-looking, simultaneous analysis
of capital planning processes and capital needs at large bank holding
companies. The CCAR represents a substantial strengthening of the
Federal Reserve’s approach to ensuring that large bank holding companies
have thorough and robust processes for managing and allocating their
capital resources, and that these are supported by effective
risk-measurement and risk-management practices.

2. Is CCAR 2012 a stress test?

Capital stress tests are only one, albeit an important, part of
CCAR 2012. All participating BHCs will conduct their capital stress
tests, under Federal Reserve review, to assess whether they would have
sufficient capital to continue operations and to lend to households and
businesses, even under adverse conditions. These stress test results are
an important tool for a firm’s management and board of directors in
their evaluation of available capital resources. The supervisory
assessment of the BHCs’ stress tests will provide supervisors with
insight into the risk-measurement and risk-management capabilities of
these firms.

In addition, for the 19 largest BHCs that participated in CCAR in
2011, the Federal Reserve will simultaneously conduct a supervisory
stress test to help assess the capital plans and the appropriateness of
capital levels for those firms.

In the review of the capital plans and stress test evaluations, the
Federal Reserve will consider the comprehensiveness of the plan,
including an assessment of BHCs’ practices for capturing, measuring, and
estimating potential losses under stress from the risks stemming from
all of a BHC’s activities. The Federal Reserve will also assess a BHC’s
capital policies; the reasonableness of a BHC’s assumptions and analysis
supporting its internal capital adequacy assessment; and the BHC’s
ability to maintain capital above each minimum regulatory ratio and
above a 5 percent tier 1 common ratio under expected and stressful
conditions, with stress testing carried out both by the firms and the
Federal Reserve.

3. Is the baseline or stress scenario the Federal Reserve’s
forecast for the economy?

Neither scenario is the Federal Reserve’s forecast. The Supervisory
Baseline broadly follows the consensus outlook from private forecasters
as of mid-November. The Supervisory Stress scenario is not a forecast
for the U.S. or global economy, but a stress scenario that is useful to
gauge the strength and resiliency of the 19 BHCs. The stress 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 particular, this constitutes a deep recession by
historical standards where the unemployment rate increases by an amount
similar to that experienced, on average, in severe recessions such as
those in 1973-1975, 1981-82, and 2007-2009.

4. Will the European situation be taken into account?

The Supervisory Stress scenario provided by the Federal Reserve
includes a sizable shortfall in U.S. economic activity and employment,
accompanied by a notable decline in global economic activity. In
addition, a global market shock will be performed that is based on
market price movements seen during the second half of 2008, a time of
significant volatility, with adjustments made to incorporate potential
sharp market price movements in European sovereign and financial
sectors.

5. What happens if the Federal Reserve objects to a capital plan?

CCAR 2012 is a broad supervisory exercise that considers a range of
factors for the participating BHCs — the internal capital planning
process, capital distribution policies, pro forma, post-stress capital
ratios, and projected path to compliance with regulatory capital
standards agreed to by the Basel Committee on Banking Supervision as
they are implemented in the United States. Supervisors will evaluate
each of these factors and the supervisory response will correspond to
any observed deficiencies. For example, a BHC with incomplete or
insufficient capital planning processes, or with projected capital
ratios that do not appear appropriate given its risk profile and the
economic scenarios, may be required to devote more resources to
developing and implementing more appropriate processes, may be
restricted from some or all capital distributions, and may be required
to take actions to improve its capital adequacy.

6. What are you going to disclose to the public?

The Federal Reserve is committed to increasing the transparency of
the CCAR process. This will foster market discipline and ultimately make
the largest BHCs more resilient as better-informed investors encourage
banks toward more prudent risk-taking. The Federal Reserve is releasing
the baseline and stress scenarios that will be used to assess the
appropriate levels of BHC capital. Moreover, at the completion of the
exercise, the Federal Reserve will disclose its estimates of revenues
and losses, as well as pro forma, post stress capital ratios for each of
the 19 BHCs.

7. How do the capital plans intersect with what is mandated by the
Dodd-Frank Act?

The capital plans complement Dodd-Frank in two ways. First, the
capital planning requirements are consistent with the Federal Reserve’s
obligations to impose enhanced capital and risk-management standards on
large financial firms under the Dodd-Frank Act. Second, Dodd-Frank
mandates that the Federal Reserve conduct annual stress tests on all
bank holding companies with $50 billion or more in assets to determine
whether they have the capital needed to absorb losses in baseline,
adverse, and severely adverse economic conditions. These tests will be
integrated into the ongoing assessments of BHC capital required by the
capital plans rule. As set forth in the law, the Federal Reserve will be
implementing the specific stress testing requirements of Dodd-Frank over
the next year. The Federal Reserve expects that the stress tests
required in Dodd-Frank will be an important component of the annual
assessment of BHC capital plans.

** Market News International Washington Bureau: 202-371-2121 **

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