What’s new with the Fed’s 2020 bank stress tests?
The Federal Reserve’s bank stress tests will look significantly different in 2020, thanks to regulatory changes and the dramatic economic turmoil brought on by coronavirus pandemic.
Here’s how the annual exam of bank health is getting changed.
Originally, the Fed planned to test bank capital plans – due at the beginning of April – against a hypothetical economic downturn it published in February. The coronavirus outbreak upended those plans, as the economic hit caused by widespread lockdowns quickly dwarfed the downturn envisioned by the test.
So in May, the Fed told banks it was adding “sensitivity analyses” to the upcoming test meant to capture “current economic conditions.” The Fed has yet to say more about exactly what the extra analysis will look like, or areas of focus.
NO MORE ‘PASS/FAIL’
In prior years, the Fed would typically pass a bank’s capital plan, or reject it and order fixes. The high drama of the public fail meant a lot of angst for bank executives, wary of an investor backlash. Fed officials too had expressed a desire to come up with a less volatile way to guide appropriate bank capital plans.
So, for the first time since the tests were created, the Fed will do away with the “pass/fail” dynamic this year, and adopt a more nuanced approach.
NEW ‘STRESS CAPITAL BUFFER’
The new approach the Fed has adopted is called a “stress capital buffer,” meant to combine existing capital requirements with each bank’s stress test results. Now, each bank will not receive a passing or failing grade. Instead it will be told how much capital they will have to hold in addition to the minimum buffers dictated by the test. The new approach will be used for the first time during the 2020 stress tests.
Another complication this year is the political pressure the Fed is under to curtail bank dividends. Fed Vice Chairman Randal Quarles has been pressed by Democrats in Congress to order banks to hold onto that capital rather than give it out to investors. The Fed has resisted those calls so far, even as banks in Europe have already trimmed theirs, with Quarles saying the stress test results will dictate what happens to bank capital.
For their part, U.S. banks have argued against cutting dividends, saying they are a relatively small amount of funds and banks have performed well so far in the pandemic.
Source: Reuters (Reporting by Pete Schroeder; editing by Edward Tobin)