Stress Testing: A Look Into the Fed’s Black Box

On March 26th, the Federal Reserve (Fed) announced the results of its annual Comprehensive Capital Analysis and Review (CCAR). [1] This year the Fed assessed the capital plans of 30 bank holding companies (BHCs)—12 more than last year—and objected to five plans (four due to deficiencies in the quality of capital planning process, and one for falling below quantitative minimum capital ratios). Two other US BHCs had to “take a mulligan” and quickly resubmit their plans with reduced capital actions to remain above the quantitative floors.

The CCAR 2014 results send two overarching messages: The quality of the capital planning process is now a more prominent aspect of the Fed’s focus (versus just the quantity of capital), and the bar continues to rise, especially for the largest firms. Therefore, BHCs must continue to improve their capital planning processes regardless of whether they meet quantitative capital requirements.

The Fed has been signaling its higher qualitative expectations for some time, particularly in its August 2013 guidance. Our view has been that the increase in supervisory transparency leading up to CCAR 2014 was meant as fair warning that the Fed intended to raise the bar. [2] This year’s disclosures outlined the Fed’s rationale for each of the qualitative failures for the first time. Although this increased transparency will help BHCs better prepare for future CCARs, we believe it also reduces the Fed’s tolerance for shortfalls in the firms’ compliance efforts.

Fed objections this year covered both US and foreign-owned BHCs. Three of the six largest US BHCs were unable to make desired capital distributions, in part due to the Fed using its own forecasting models for the first time (rather than relying on the BHCs’ models). In addition, half of foreign-owned BHCs’ plans were rejected due to qualitative issues (three of six). These outcomes suggest that the Fed will likely continue to use its models to exert downward pressure on stressed capital ratios to keep capital in the system, supplemented by its heightened qualitative assessments.

The complete publication (available here) provides our quantitative and qualitative analyses of the CCAR 2014 results and lessons learned, and our view of enhancements needed to meet increasingly heightened regulatory expectations.

Endnotes:

[1] See PwC’s First take: CCAR stress testing (March 27, 2014). The release of CCAR results followed the Fed’s earlier release of its Dodd-Frank Act Stress Test (DFAST) results on March 20th.
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[2] See PwC’s Regulatory Brief, Stress testing: Failures on the horizon? (November 2013).
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