The Federal Reserve should scrap two elements of its earlier plan to develop a new stress capital buffer for large banks, Federal Reserve Vice Chairman for Supervision Randal Quarles said Sept. 5.
The proposed stress capital buffer, or SCB, would simplify the current capital regime for big banks, but the Fed's proposal can be streamlined further, Quarles said in a speech at a conference in Frankfurt. He reiterated that he hopes the Fed can finalize the SCB for large banks' 2020 stress testing cycle, saying he expects the Fed to put out a revised proposal for public comment "in the near future."
The proposed stress capital buffer for large banks would replace their current capital conservation buffer of 2.5% of risk-weighted assets, an extra cushion that sits atop banks' capital rules. The current buffer applies the extra 2.5% cushion equally among all firms, but the SCB would develop specific requirements for each bank depending on how they performed in their most recent stress-test results. Their individual buffers could not be lower than 2.5%.
Quarles laid out two changes he would like to make to the Fed's original SCB proposal after reviewing public comments on the April 2018 proposal.
The original plan would add a separate stress leverage buffer requirement, one that treats all types of assets the same without taking into account the different risks they pose. The Fed already has that type of "blunt instrument" in place through its rules requiring banks to meet certain leverage ratios, so it "seems out of place and unnecessary to add a separate leverage capital buffer," Quarles said.
He also called for removing a requirement in the proposed SCB that banks prefund their planned dividend payments for the next four quarters. The SCB already can curb dividends and other planned capital distributions if a bank's capital is not high enough, and requiring dividend prefunding is a "needless redundancy."
"I believe it is better to focus on the root cause of our concerns and take a comprehensive approach to ensuring that banks have sufficient capital, rather than focus on the individual elements of capital distributions," he said.
Quarles pushed back against criticisms that removing the prefunding of dividends could make the process more procyclical — or less likely to provide stability against the ebbs and flows of a business cycle.
One potential way of limiting procyclicality would be to set a higher baseline for the Fed's countercyclical capital buffer, or CCyB, a tool the Fed has declined to use so far but that is designed to build up extra capital cushions at big banks in good times so that they can keep lending if the economy slows. A nonzero standard level for the CCyB would let Fed officials reduce it during a downturn so that banks do not pull back on lending, Quarles said.
The other option would be to increase the risk-weighted assets minimum in the proposed SCB from 2.5% to a higher level.
"Raising the fixed floor would be simpler to execute than the CCyB proposal because raising the floor once and for all times would not require the Board to make complex, real-time decisions about how to adapt the regulatory framework to the evolving vulnerabilities to the economy," Quarles said.
That option would also provide more transparency and predictability since it would reduce how much a firm's capital rules would vary over time, he added.
Quarles also mentioned he'd be open to additional changes to the SCB to reduce volatility and give banks better notice about their performance in examinations, so they can better plan their capital distributions.
