Tag: Stress tests

Money Market Mutual Funds: Stress Testing & New Regulatory Requirements

Jeremy Berkowitz is Vice President in NERA’s Global Securities and Finance Practice. This post is based on a NERA publication authored by Dr. Berkowitz, Patrick E. Conroy, and Jordan Milev.

In July 2014, the Securities and Exchange Commission (SEC) adopted a package of reforms to the regulatory framework governing money market mutual funds. The SEC believes the new rules will enhance the safety and soundness of the money market fund industry during periods of market distress, when redemptions in some funds may increase substantially. [1]

The new rules require institutional prime (general purpose) and institutional municipal money market mutual funds to price and transact at a “floating” net asset value (NAV), permit certain money market mutual funds to charge liquidity fees, and allow the use of redemption gates to temporarily halt withdrawals during periods of stress.

Enhancing Prudential Standards in Financial Regulations

The following post comes to us from Franklin Allen, Professor of Economics at the University of Pennsylvania and Imperial College London; Itay Goldstein, Professor of Finance at the University of Pennsylvania;
 and Julapa Jagtiani and William Lang, both of the Federal Reserve Bank of Philadelphia.

The recent financial crisis has generated fundamental reforms in the financial regulatory system in the U.S. and internationally. In our paper, Enhancing Prudential Standards in Financial Regulations, which was recently made publicly available on SSRN, we discuss academic research and expert opinions on this vital subject of financial stability and regulatory reforms.

Despite the extensive regulation and supervision of U.S. banking organizations, the U.S. and the world financial systems were shaken by the largest financial crisis since the Great Depression, largely precipitated by events within the U.S. financial system. The new “macroprudential” approach to financial regulations focuses on both the risks arising in financial markets broadly and those risks arising from financial distress at individual financial institutions.


Key Points from 2015 Dodd-Frank Act Stress Test (DFAST)

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication by Mike Alix and Steve Pearson.

For the first time all banks passed DFAST this year, but this unfortunately told us nothing about their chances of passing last week’s CCAR qualitative assessment.

The DFAST results published March 5, 2015 are the Federal Reserve’s (Fed) first stress test results released in 2015. On March 11th, the Fed released the more important Comprehensive Capital Analysis and Review (CCAR) results which told us whether the banks passed the Fed’s qualitative and quantitative assessments in order to return more capital to shareholders. [1]


Financial Market Utilities: Is the System Safer?

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

It has been two and a half years since the Financial Stability Oversight Council (FSOC) designated select financial market utilities (FMUs) as “systemically important.” These entities’ respective primary supervisory agencies have since increased scrutiny of these organizations’ operations and issued rules to enhance their resilience.

As a result, systemically important FMUs (SIFMUs) have been challenged by a significant increase in regulatory on-site presence, data requests, and overall supervisory expectations. Further, they are now subject to heightened and often entirely new regulatory requirements. Given the breadth and evolving nature of these requirements, regulators have prioritized compliance with requirements deemed most critical to the safety and soundness of financial markets. These include certain areas within corporate governance and risk management such as liquidity risk management, participant default management, and recovery and wind-down planning.


G-SIB Capital: A Look to 2015

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication by Dan Ryan, Kevin Clarke, Roozbeh Alavi, and Armen Meyer. The complete publication, including appendix, is available here.

On December 9, 2014, the Federal Reserve Board (FRB) issued a long-awaited proposal to impose additional capital requirements on the US’s global systemically important banks (G-SIBs). The proposal implements the Basel Committee on Banking Supervision’s (BCBS) G-SIB capital surcharge framework that was finalized in 2011, but also proposes changes to BCBS’s calculation methodology resulting in significantly higher surcharges for US G-SIBs compared with their global peers.

The proposal, which we expect will be finalized in 2015, requires US G-SIBs to hold additional capital (Common Equity Tier 1 (CET1) as a percentage of Risk Weighted Assets (RWA)) equal to the greater of the amount calculated under two methods. The first method is consistent with BCBS’s framework, and calculates the amount of extra capital to be held based on the G-SIB’s size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity. The second method is introduced by the US proposal, and uses similar inputs but replaces the substitutability element with a measure based on a G-SIB’s reliance on short-term wholesale funding (STWF).


Bank Capital Plans and Stress Tests

The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication authored by H. Rodgin Cohen, Andrew R. Gladin, Mark J. Welshimer, and Lauren A. Wansor.

On October 16, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) issued its summary instructions and guidance [1] (the “CCAR 2015 Instructions”) for its supervisory Comprehensive Capital Analysis and Review program for 2015 (“CCAR 2015”) applicable to bank holding companies with $50 billion or more of total consolidated assets (“Covered BHCs”). Thirty-one institutions will participate in CCAR 2015, including the 30 Covered BHCs [2] that participated in CCAR in 2014, as well as one institution that is new to the program. [3]


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

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication; the complete publication, including graphs, tables, and appendix, is available here.

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.


Stress Tests Demonstrate Strong Capital Position of US Banks

The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication by H. Rodgin Cohen, Andrew R. Gladin, and Joel Alfonso.

On March 20, 2014, the Federal Reserve announced the summary results of the Dodd-Frank Act 2014 supervisory stress tests for the 30 largest U.S. banking organizations. The results demonstrate the sharply enhanced capital strength and resiliency of the U.S. banking system. Under an “extreme stress scenario”, these U.S. banking organizations could absorb an extraordinary downturn in “pre-provision net revenues” and an unprecedented level of loan losses and still maintain capital levels well above minimum regulatory requirements and almost 40% above the actual capital ratios in 2009.


Regulation by Hypothetical

The following post comes to us from Mehrsa Baradaran at the University of Georgia, School of Law.

U.S. banking regulation resembles a cat-and-mouse game of industry change and regulatory response. Often, a crisis or industry innovation will lead to a new regulatory regime. Past regulatory regimes have included geographic restrictions, activity restrictions, disclosure mandates, risk management rules, and capital requirements. But the recently enacted Dodd-Frank Act introduced a new strain of banking-industry supervision: regulation by hypothetical. Regulation by hypothetical refers to rules that require banks to predict future crises and weaknesses. Those predictions—which by definition are speculative—become the basis for regulatory intervention. Two illustrative instances of this regulation were codified in Dodd-Frank: stress tests and living wills. They are two pillars on which Dodd-Frank builds to manage risk in systemically important financial institutions (SIFIs). [1] As I argue in my forthcoming article, regulation by hypothetical in Dodd-Frank should be abandoned for three reasons: it relies on a faulty premise, tasks an agency with a conflicted mission, and likely exacerbates the moral hazards involved with governmental sponsorship of private institutions. Because of these weaknesses, the regulation-by-hypothetical regime must be either abandoned (my first choice) or strengthened. One way to strengthen these hypothetical scenarios would be to conduct financial war games.


Dodd-Frank Enhanced Prudential Standards for Foreign Banks with Limited US Footprints

The following post comes to us from Luigi L. De Ghenghi and Andrew S. Fei, attorneys in the Financial Institutions Group at Davis Polk & Wardwell LLP, and is based on a Davis Polk client memorandum; the full publication, including diagrams, tables, and flowcharts, is available here.

The Federal Reserve has issued a final rule adopting a tiered approach for applying Dodd-Frank enhanced prudential standards to foreign banking organizations (“FBOs”). Under the tiered approach the most burdensome requirements (e.g., the requirement to establish a top-tier U.S. intermediate holding company) will only apply to FBOs with large U.S. operations, whereas fewer requirements will apply to FBOs with limited U.S. footprints.

We have summarized below the Dodd-Frank enhanced prudential standards that will apply to the following FBOs with limited U.S. footprints:


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