–Next Year’s Stress Tests to Cover Second Quarter Instead of First
By Denny Gulino
WASHINGTON (MNI) – Even some of those banks that passed the latest
stress tests could use “significant” improvement and the tests
themselves will be better by the time they are held again, in the second
quarter of next year, Federal Reserve Gov. Daniel Tarullo said Tuesday.
Speaking at the Chicago Fed Annual Risk Conference, he said the Fed
is giving some criticisms of the tests “extensive thought” and academics
are being consulted as next year’s tests are being designed.
The conference is closed to news coverage beyond Tarullo’s
prepared speech, made available in advance.
When new Dodd-Frank rules are implemented, bank holding companies
will have to disclose the stress test results themselves, Tarullo said,
“providing markets and stakeholders with more information about the
risk-management practices.”
The Fed’s March 13 disclosures of the results for the top 19
financial institutions — 15 of which passed the capital standards test
— “seem to have struck about the right balance between providing useful
information to investors, counterparties and the public, on the one
hand, and protecting proprietary information whose release might result
in competitive harm to firms,” he said.
The latest tests’ biggest surprise was the failure of Citigroup to
pass the capital standard and so be denied the ability to raise its
dividend. Its stock plunged 4% in afterhours trading that day.
MetLife, which objected to the Fed’s standards being applied to
what is primarily an insurance company, SunTrust and Ally Financial also
failed the capital standard test.
Tarullo defended one of the most criticized criteria applied this
year, a scenario that included a “nonlinear” 20% decline in house prices
across the nation. The criteria was necessarily non-linear, meaning
“higher overall losses” than a straight 20% because in such a scenario
“prices would decline substantially more in some markets and less in
others, and losses in areas where house prices decline more would be
disproportionately greater” than losses in other areas, he said.
Tarullo conceded the latest stress tests may have overstated the
probable behavior of banks in an actual crisis, assuming they would go
ahead with stated capital plans even though they probably would cut back
their distributions under stress.
“We are forming an advisory group of academics and other experts to
advise our international model-validation team on an ongoing basis,” he
said. Later in the year, the Fed will convene a modeling symposium “to
bring a broader array of voices into the discussion.”
Some of the banks complained the Fed’s estimate of losses under the
stress scenarios were way off, and Tarullo said the Fed is “mindful of
the statements.”
“We may gain greater insight into the source of these differences
as we proceed with the review of our modeling,” he said.
The first two sets of stress tests covered first quarter capital
plans but next time it “will apply to capital actions beginning in the
second quarter of 2013,” he said. Also, the Fed “will be able to begin
the analysis earlier, thereby providing more time to both firms and
supervisors to run the stress tests.”
Many of the firms, he said, “were frustrated by the limitations on
how much supervisors would communicate about modeling assumptions.” But
“Here, there is some tension between the desirability of providing more
information to firms and the importance of not turning capital planning
into a mechanical compliance exercise.”
“We do not want to encourage a world in which everyone simply
applies the same risk-management model,” he said. Instead, the Fed wants
a “multidimensional” process of evaluating and modeling risk.
The Dodd-Frank Act requires a third stress scenario be developed in
addition to the two imposed this year and the Fed is currently accepting
comments on that part of the regulation. The next stress tests will also
be delving into more “granular” information, he said.
The stress tests are “no more a panacea for the supervision of
large financial institutions than capital requirements,” he said, but
they are forward looking while the capital standards are lagging
indicators.
Yet the Fed considers the tests a “watershed” improvement in
supervisory techniques, he said. And they will be a particularly useful
tool in the next few years in assessing “whether large holding companies
will readily and comfortably meet the new capital requirements related
to various Basel agreements as they take effect in the United States.
“Most of the 19 bank holding companies have made considerable
progress in their internal capital planning processes,” he said.
“However, there appears to be room for improvement at virtually every
firm, and at some firms the amount of work need is still significant.”
** MNI Washington Bureau: 202-371-2121 **
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