Federal Reserve Capital Plan and Stress Test Requirements

Mark J. Welshimer is the deputy managing partner of the Financial Institutions Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication; the full version, including footnotes, is available here.

On November 22, 2011, the Board of Governors of the Federal Reserve System (the “Board”) published a final rule (the “Final CCAR Rule”) requiring most bank holding companies (“BHCs”) with $50 billion or more of total consolidated assets (“Covered BHCs”) to submit annual capital plans, with their related stress test requirements, to the appropriate Federal Reserve Bank and to generally obtain regulatory approval before making capital distributions, which include dividends and purchases of capital securities and instruments. The Final CCAR Rule expands the capital plan requirements from 19 to 34 BHCs, including, for the first time, foreign-owned BHCs. In addition, the Board released (i) two sets of instructions (the “Instructions”) that provide guidance on compliance with capital requirements in the Final CCAR Rule, one for Covered BHCs that did not participate in the 2011 Comprehensive Capital Analysis and Review (“CCAR” and such BHCs, the “non-CCAR BHCs”) and another for the 19 Covered BHCs that participated in the 2011 CCAR (the “CCAR BHCs”) and (ii) the data templates (namely, the FR Y- 14A and FR Y-14Q) that will be used to collect data from the CCAR BHCs to support the data collection contemplated by the Final CCAR Rule. The Final CCAR Rule generally incorporates the core features of the Board’s June 17, 2011 proposal regarding capital planning (the “Proposed CCAR Rule”).

As part of the capital planning exercise, Covered BHCs on an annual basis must submit comprehensive capital plans, including pro forma capital analyses and supporting projections, based on four scenarios – a BHC-defined baseline scenario; a baseline scenario provided by the Board; at least one BHC-defined stressed scenario; and a stressed scenario provided by the Board. In addition, six BHCs with large trading operations (the “Trading BHCs”) will be required to estimate potential losses stemming from a hypothetical global market shock based on market price movements seen during the second half of 2008, with adjustments made to incorporate potential sharp market price movements in European sovereign and financial sectors.

The Final CCAR Rule will become effective December 30, 2011. Covered BHCs will be required to submit their first comprehensive capital plans under the Final CCAR Rule by January 9, 2012, covering the nine quarter period commencing with the fourth quarter of 2011 and ending with the fourth quarter of 2013.

Although the Final CCAR Rule only applies to large BHCs with over $50 billion in assets, it remains to be seen whether the Board will, over time, come to expect BHCs that do not technically meet the size requirement to adopt some portions of the capital planning and stress test methodologies of the Final CCAR Rule as part of their own policies and procedures as a prudential supervisory matter.

Capital Planning Requirements

Applicability

The Final CCAR Rule will generally apply to every top-tier BHC domiciled in the United States that has $50 billion or more in “total consolidated assets”. “Total consolidated assets” is defined as the average of a company’s total consolidated assets over the previous four calendar quarters, as reflected on the BHC’s FR Y-9C (Consolidated Financial Statements for Bank Holding Companies). The Final CCAR Rule also applies to any BHC that the Federal Reserve determines, by order, is subject to its requirements based on the institution’s size, level of complexity, risk profile, scope of operations or financial condition.

Annual Capital Planning Requirement

As under the Proposed CCAR Rule, the Final CCAR Rule requires a Covered BHC to develop and maintain a capital plan. At least annually, the board of directors, or a designated committee, of a Covered BHC is required to review the “robustness” of the Covered BHC’s process for assessing capital adequacy, ensure that any deficiencies in its process for assessing capital adequacy are appropriately remedied and approve its capital plan. Capital plans will be due by January 5th each year. The Federal Reserve will object or issue a non-objection to such capital plans, in whole or in part, by March 31. For 2012 only, the deadline for submission has been extended to January 9th, and the Federal Reserve will respond by March 15, 2012 if a Covered BHC submits its capital plan on a timely basis.

Mandatory Components of a Capital Plan

Each capital plan must include the following mandatory components:

  • an assessment of the expected uses and sources of capital over the requisite “planning horizon” that reflects the Covered BHC’s size, complexity, risk profile and scope of operations, assuming both expected and stressful conditions. The “planning horizon” for these purposes must be at least nine quarters, beginning with the quarter preceding the quarter in which the Covered BHC submits its capital plan (for example, using the initial capital plan as an example, beginning with the fourth quarter of 2011 and continuing through the fourth quarter of 2013);
  • a detailed description of the Covered BHC’s process for assessing capital adequacy, including a discussion of how under expected and stressful conditions it will (i) maintain capital commensurate with its risks, maintain capital above the minimum regulatory capital ratios and above a Tier 1 common equity ratio of 5 percent and serve as a source of strength to its subsidiary depository institutions and (ii) maintain sufficient capital to continue its operations by maintaining ready access to funding, meeting its obligations to creditors and other counterparties and continuing to serve as a credit intermediary;
  • the Covered BHC’s capital policy; and
  • a discussion of any expected changes to the Covered BHC’s business.

The first component listed above requires an assessment of the expected uses and sources of capital over the planning horizon under both expected and stressful conditions. This assessment must contain the following elements:

  • estimates of projected revenues, losses, reserves and pro forma capital levels, including any minimum regulatory capital ratios and any additional capital measures deemed relevant by the Covered BHC, over the planning horizon under expected conditions and under a range of stressed scenarios, including any scenarios provided by the Federal Reserve and at least one stressed scenario developed by the Covered BHC appropriate to its business model and portfolios;
  • a calculation of the pro forma Tier 1 common equity ratio over the planning horizon under expected conditions and under a range of stressed scenarios and a discussion of how the Covered BHC will maintain a pro forma Tier 1 common equity ratio above 5 percent under the stressed scenarios required by the Final CCAR Rule;
  • a discussion of the results of any stress test required by law or regulation, and an explanation of how the capital plan takes these results into account; and
  • a description of all planned “capital actions” over the planning horizon. A “capital action” for purposes of the Final CCAR Rule means any issuance of a debt or equity capital instrument, any “capital distribution” and any similar action that the Federal Reserve determines could impact a Covered BHC’s consolidated capital. A “capital distribution” means a redemption or repurchase of any debt or equity capital instrument, a payment of common or preferred stock dividends, a payment that may be temporarily or permanently suspended by the issuer on any instrument that is eligible for inclusion in the numerator of any minimum regulatory capital ratio and any similar transaction that the Federal Reserve determines to be in substance a distribution of capital.

Baseline and Stress Scenarios

As noted above, in assessing its expected uses and sources of capital over the planning horizon, a Covered BHC must estimate projected revenues, losses, reserves and pro forma capital levels under expected conditions and under a range of stressed scenarios. The Instructions provide additional detail regarding the scenarios that Covered BHCs must use to support their pro forma capital analyses and projections. In particular, the Instructions state that the pro forma capital analyses and supporting projections included in Covered BHCs’ annual capital plans must be based on at least four scenarios:

  • a BHC-defined baseline scenario;
  • a baseline scenario provided by the Federal Reserve (the “Supervisory Baseline scenario”);
  • at least one BHC-defined stressed scenario; and
  • a stressed scenario provided by the Federal Reserve (the “Supervisory Stress scenario”).

The Instructions indicate that the BHC-defined baseline scenario should reflect the Covered BHC’s view of the most likely path of the economy over the forecast horizon. In addition, the Instructions provide that the BHC-defined stress scenario should be “based on a coherent, logical narrative of a stressful economic environment” and should “reflect the [Covered] BHC’s unique vulnerabilities to factors that affect its exposures, activities, and risks”.

The Supervisory Baseline scenario broadly follows the consensus outlook from the “Blue Chip Economic Indicators and other sources” as of mid-November. The Supervisory Stress scenario assumes a deep recession commencing in the fourth quarter of 2011 in which the unemployment rate increases by “an amount similar to that experienced, on average, in severe recessions such as those in 1973-1975, 1981- [19]82, and 2007-2009, with a sizable shortfall in U.S. economic activity and employment, accompanied by a notable decline in global economic activity”. The Supervisory Stress scenario also includes hypothetical sharp declines in asset prices and risk premia increases.

In addition to the above-described scenarios, the Trading BHCs – which comprise Bank of America Corporation, Citigroup Inc., The Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley and Wells Fargo & Company – will also be required to conduct a stress test of their trading book, private equity positions and counterparty credit exposures as of market close on November 17, 2011. For purposes of this “global market shock” scenario, losses will be calculated based on an “instantaneous re-pricing of trading and private equity positions for the changes in market pricing variables that occurred over the period June 30, 2008, to December 31, 2008”. The Instructions for CCAR BHCs state that this scenario should reflect where appropriate additional stresses related to the ongoing events in Europe and include estimates of changes in the size of counterparty exposures and the impact of deterioration of counterparties’ creditworthiness.

Data Submissions

In connection with the submission of an annual capital plan, a Covered BHC is required to provide certain data to the Federal Reserve. Data required by the Federal Reserve may include, but are not limited to, information regarding the Covered BHC’s financial condition, structure, assets, risk exposure, policies and procedures, liquidity and management. Failure to submit complete data to the Federal Reserve in a timely manner may be a basis for objection to a capital plan. CCAR BHCs will generally be required to report all required data elements pertaining to their 2012 capital plans pursuant to the schedules specified in the FR Y-14A and FR Y-14Q forms.

Federal Reserve Review of a Capital Plan

The Federal Reserve will consider the following factors in reviewing a Covered BHC’s capital plan:

  • the comprehensiveness of the capital plan;
  • the reasonableness of the Covered BHC’s assumptions and analysis underlying the capital plan and its methodologies for reviewing the robustness of its capital adequacy process; and
  • the Covered BHC’s ability to maintain capital above each minimum regulatory capital ratio and above a Tier 1 common equity ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon.

In reviewing a Covered BHC’s capital plan, the Federal Reserve will also consider relevant supervisory information about the Covered BHC and its subsidiaries, the Covered BHC’s regulatory and financial reports and, as applicable, the Federal Reserve’s own pro forma estimates of the Covered BHC’s potential losses, revenues, reserves and resulting capital adequacy under expected and stressful conditions. It appears that the Federal Reserve, at least in 2012, will only generate supervisory pro forma estimates for CCAR BHCs.

Federal Reserve Objection to a Capital Plan

The Federal Reserve may object to a capital plan for any of the following reasons:

  • the Covered BHC has material unresolved supervisory issues, including but not limited to issues associated with its capital adequacy process;
  • the assumptions and analysis underlying the capital plan, or the Covered BHC’s methodologies for reviewing the robustness of its capital adequacy process, are not reasonable or appropriate;
  • the Covered BHC failed to demonstrate it could maintain capital above each minimum regulatory capital ratio or above a Tier 1 common equity ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon; or
  • the Covered BHC’s capital planning process or proposed capital distributions otherwise constitute an unsafe or unsound practice, or would violate any law, regulation or Federal Reserve order, directive, written agreement or condition.

Resubmission of a Capital Plan

A Covered BHC is required to update and re-submit its capital plan to the Federal Reserve within 30 days (subject to an extension of up to an additional 60 days) of the occurrence of any of the following events:

  • the Covered BHC determines there has been or will be a “material change” in the Covered BHC’s risk profile, financial condition or corporate structure since the Covered BHC adopted the capital plan;
  • the Federal Reserve objects to the capital plan; or
  • the Federal Reserve directs the Covered BHC to revise and resubmit its capital plan for any of the following reasons:
    • the capital plan is incomplete or it, or the Covered BHC’s internal capital adequacy process, contains material weaknesses;
    • there has been or will likely be a material change in the Covered BHC’s risk profile, financial condition or corporate structure;
    • the stressed scenario or scenarios developed by the Covered BHC are not appropriate to its business model and portfolios, or changes in financial markets or the macro-economic outlook that could impact the Covered BHC’s risk profile and financial condition require the use of updated scenarios; or
    • the capital plan or condition of the Covered BHC raises any issues to which the Federal Reserve could object to in its review of a capital plan.

The Federal Reserve will respond to a resubmitted capital plan within 75 days of its resubmission.

Prior Approval Requirements

A Covered BHC generally must obtain prior approval from the Federal Reserve before making capital distributions under any of the following circumstances (regardless of whether the distribution in question had been provided for in a capital plan that had received a non-objection, if applicable):

  • after giving effect to the capital distribution, the Covered BHC will not meet a minimum regulatory capital ratio or a Tier 1 common equity ratio of at least 5 percent;
  • the Federal Reserve notifies the Covered BHC that it has determined that (i) the capital distribution will result in a material adverse change to the Covered BHC’s capital or liquidity structure or (ii) the Covered BHC’s earnings were materially underperforming projections;
  • the dollar amount of the capital distribution will exceed the amount described in the Covered BHC’s approved capital plan; or
  • the capital distribution will occur after the occurrence of an event requiring resubmission (other than an objection to a capital plan) and before the Federal Reserve has acted on the resubmitted plan.

A Covered BHC is not permitted to make any capital distributions, to the extent the Federal Reserve has objected to its capital plan, until the Federal Reserve issues a non-objection to the Covered BHC’s capital plan.

The Final CCAR Rule provides a limited exception to the above rule regarding prior approval for capital distributions (together with all capital distributions made under this limited exception) that do not exceed one percent of the Covered BHC’s Tier 1 capital as reported on its first quarter FR Y-9C. This exception may only be utilized by “well-capitalized” Covered BHCs. In addition, before a distribution can be made pursuant to this exception, Covered BHCs must provide the Federal Reserve with notice 15 calendar days before the proposed capital distribution, and the Federal Reserve must not object to the proposed distribution.

Disclosure of Supervisory Post-Stress Capital Analysis

The Instructions for CCAR BHCs indicate that the Federal Reserve intends to publish the results of the supervisory stress test component of CCAR 2012 on a BHC-specific basis. The Instructions for non- CCAR BHCs do not include a comparable discussion of disclosure, apparently reflecting a Federal Reserve decision not to publish results for non-CCAR BHCs. The Federal Reserve took a similar step at the end of the first large bank capital stress test program in 2009, known as the Supervisory Capital Assessment Program, or “SCAP”. The Federal Reserve did not publish results of the 2011 CCAR review.

The Instructions for CCAR BHCs state that the purpose of releasing this information “is to provide insight to market participants into the resilience of the BHCs [in] very stressful hypothetical environments and to provide information about the post-stress capital analysis performed by supervisors during the CCAR 2012 process.” The information to be released will include, among other things, BHC-specific information about pro forma, post-stress capital ratios – leverage, Tier 1 risk-based and total risk-based capital ratios and the Tier 1 common equity ratio – including the minimum value of these ratios over the planning horizon.

Common Dividend Payouts

The Instructions repeat, for both CCAR BHCs and non-CCAR BHCs, the statement from the Federal Reserve’s November 2010 Revised Temporary Addendum to SR Letter 09-4 that common dividend payout ratios above 30% of projected after-tax net income will receive “particularly close scrutiny”. Like the Revised Temporary Addendum, the statement appears to be limited to common dividends and does not seem to reference other capital distributions, including stock repurchases.

Modifications and Clarifications

Although the Final CCAR Rule generally incorporates the fundamental features of the Proposed CCAR Rule, certain aspects of the Proposed CCAR Rule were modified and clarified. Some of the most important of these modifications and clarifications are as follows:

Compliance with Basel III. The Proposed CCAR Rule did not address the Federal Reserve’s expectations for compliance with Basel III. The Instructions now indicate that the Federal Reserve expects that a Covered BHC will demonstrate that it can achieve “readily and without difficulty the ratios required by the Basel III framework as they would come into effect in the United States”.

The Instructions for CCAR BHCs (but not the Instructions for non-CCAR BHCs) provide that the CCAR BHCs should provide a “transition plan” that includes pro forma estimates under baseline conditions of the Covered BHC’s regulatory capital ratios under the proposed Basel III capital framework. Regarding a Covered BHC’s obligation to satisfy the Basel III minima, the Instructions for CCAR BHCs provide that “BHCs that meet the minimum ratio requirement during the Basel III transition period but remain below the 7 percent Tier 1 common equity target (minimum plus conservation buffer) will be expected to maintain prudent earnings retention policies with a view to meeting the conservation buffer as soon as reasonably possible.”

CCAR BHCs that exceed the Basel III transition targets over the near term, but do not yet meet the fully-phased in targets, are expected “to submit plans reflecting steady accretion of capital at a sufficient pace to demonstrate continual progress toward full compliance with the proposed Basel III framework”. The Instructions for CCAR BHCs go on to note that these CCAR BHCs should “demonstrate an ability to maintain no less than steady progress along a path between its existing capital ratios and the fully-phased in Basel III requirement in 2019. The Federal Reserve will closely scrutinize plans that fall short of this supervisory expectation.” In addition, the Instructions for CCAR BHCs state that the “Federal Reserve expects that BHCs that have achieved full compliance with the fully-phased in Basel III ratios would not be constrained on distributions by Basel III considerations, provided the BHC’s forecast suggests that it would maintain full compliance during the planning horizon through December 31, 2016 . . . .” and “any BHC performance projections that suggest that ratios would fall below the transitional Basel III targets at any point over the Basel III projection period would be accompanied by proposed actions that reflect affirmative steps to improve the BHC’s capital ratios, including actions such as external capital raises”. The foregoing Federal Reserve statements could be read to suggest that no dividend increases or stock repurchases will be permitted until a Covered BHC is Basel III-compliant on a fully phased-in basis.

CCAR BHCs’ transition plans must include management’s “best estimate” of any likely surcharge pursuant to the Basel Committee on Banking Supervision’s rule regarding a common equity surcharge on certain designated global systemically important banks (the “G-SIB Surcharge”). This raises the further question of whether dividend increases or stock repurchases will be permissible until a Covered BHC is in compliance with both Basel III and the G-SIB Surcharge on a fully phased-in basis. The Instructions for CCAR BHCs also indicate that the Federal Reserve expects that these Covered BHCs will demonstrate that, assuming the G-SIB Surcharge framework is adopted, they can achieve the required ratios “readily and without difficulty” over the transition period for the G-SIB Surcharge.

Additional Guidance Regarding Potential “Black Out” Periods. The Proposed CCAR Rule’s timing sequence for submission of capital plans and Federal Reserve responses had the effect of imposing a “black out” on capital distributions for substantially all of the first quarter of each year. Commenters had expressed concern with this feature.

The Federal Reserve clarified in the Preamble that the foregoing result was not intended and that, for a capital plan submitted in the first quarter, a non-objection would cover the four-quarter period commencing with the second quarter of the year in which the capital plan is submitted and continuing through the first quarter of the following year.

Relationship to Section 165 of the Dodd-Frank Wall Street Responsibility and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). In the Preamble, the Federal Reserve notes that it intends for Covered BHCs to integrate into their capital plans the results of the company-run stress tests conducted pursuant to Section 165 of the Dodd-Frank Act. The Federal Reserve provides that it does not expect that the results of stress tests conducted under the Dodd-Frank Act alone will be sufficient to address all relevant “adverse outcomes that should be covered in a satisfactory capital plan for purposes of the final rule”, thus implying that, to comply with the Final CCAR Rule, Covered BHCs will need to conduct stress tests beyond those required under Section 165. Nevertheless, the Federal Reserve “expects that the stress scenarios that it provides under the [Final CCAR Rule] will be consistent with the stress scenarios it will provide to [Covered BHCs] for stress tests they conduct under [S]ection 165 of the Dodd-Frank Act”.

Additional Guidance Regarding the Transition Period. BHCs have been concerned that the Final CCAR Rule may have the effect of precluding dividends and other capital distributions until they receive non-objections from the Federal Reserve with respect to their 2012 capital plans – that is, a “black out” on dividends and other capital distributions during the period between the effective date of the Final CCAR Rule and the date on which capital distributions would be permitted pursuant to a Covered BHC’s initial capital plan (the “Transition Period”). The Preamble partially addresses this by providing that CCAR BHCs will continue to be subject to the Revised Temporary Addendum to SR letter 09-4 until they receive a notice of objection or non-objection from the Federal Reserve with respect to their 2012 capital plans. With respect to non-CCAR BHCs, the Preamble provides that these BHCs may make capital distributions during the Transition Period, but are expected to consult with the Federal Reserve before increasing capital distributions.

In addition, with respect to common dividends, the Instructions provide that CCAR and Non-CCAR BHCs “wishing to make a common dividend declaration prior to the March 15, 2012 decision may retain the same per share dividends as in the fourth quarter of 2011, unless the Federal Reserve explicitly informs the BHC otherwise”.

The Instructions for non-CCAR BHCs provide that these Covered BHCs should inform the Federal Reserve no later than December 9, 2011 of their intent to carry over certain capital actions (such as share repurchases and redemptions of trust preferred securities) that were previously not objected to during 2011 by their responsible Federal Reserve Bank. Similarly, the Instructions for CCAR BHCs provide that these Covered BHCs should give prior notice to the Federal Reserve of their intent to carry over certain capital actions that were previously not objected to through 2011 during the CCAR exercise in 2011, but not yet “fully executed” in 2011. The Instructions for CCAR BHCs add that a notice from a Covered BHC seeking to exercise “approved but not yet fully executed share repurchases or redemptions in 2011 should be provided to the appropriate [Federal] Reserve Bank no later than December 9, 2011” and that a response to such requests will be provided no later than December 31, 2011.

Change to 5 Percent Tier 1 Common Benchmark: Under the Proposed CCAR Rule, until January 1, 2016, a Covered BHC would be required to calculate its pro forma Tier 1 common equity ratio under expected and stressful conditions and discuss in its capital plan how it would maintain a pro forma Tier 1 common equity ratio of 5 percent under those conditions throughout the planning horizon. Under the Final CCAR Rule, this requirement remains but the time limit (that is, January 1, 2016) has been removed. In addition, the definition of “Tier 1 common ratio” in the Final CCAR Rule has been revised to say that it is the “ratio of a [Covered BHC’s] [T]ier 1 common capital to total risk-weighted assets. This definition will remain in effect until the [Federal Reserve] adopts an alternative [T]ier 1 common ratio definition as a minimum regulatory capital ratio.” In the Proposed CCAR Rule, this definition did not include the foregoing limit on its effectiveness. The foregoing changes create additional uncertainty about how the implementation of the Basel III framework will impact compliance with the requirements in the Final CCAR Rule.

The Ability to Make Distributions Following an Objection. Commenters had requested additional clarity regarding a Covered BHC’s ability to continue to make distributions pursuant to a current, approved plan if its capital plan for the upcoming planning period is objected to. In the Preamble, the Federal Reserve clarified that distributions under a current approved capital plan would be permitted following an objection to a capital plan for an upcoming year, assuming the criteria for resubmission of a capital plan have not been triggered.

The Ability to Make Distributions Following a Resubmission. The Federal Reserve modified the Proposed CCAR Rule to provide that, if the Federal Reserve has objected to a Covered BHC’s capital plan (and the Covered BHC has resubmitted its capital plan), no capital distributions may be made, except for those distributions that have not been objected to. If the capital plan has not been objected to and is, for instance, being submitted because of a material change in the risk profile of the Covered BHC, the Covered BHC must obtain the Federal Reserve’s prior approval before making a capital distribution. The extent to which capital distributions were permitted under the above described circumstances had been unclear under the Proposed CCAR Rule.

Time Frame for Reviews. The Proposed CCAR Rule did not provide an explicit time frame for a review of a re-submitted capital plan. The Final CCAR Rule provides that the Federal Reserve will respond to a resubmitted capital plan within 75 days of its resubmission, although the Federal Reserve adds that it intends to “respond to a resubmitted capital plan in a shorter time period if possible”.

Confidentiality of Capital Plan Submissions. The Federal Reserve indicated in the Preamble that the confidentiality of information submitted in connection with the Final CCAR Rule would be determined in accordance with applicable exemptions under the Freedom of Information Act and the Federal Reserve’s regulations regarding the availability of information (12 C.F.R., part 261 et seq.). One commenter had requested that such information be treated as confidential supervisory information.

Concluding Observations

The highly pessimistic stress test assumptions incorporated in the Final CCAR Rule, including, particularly, the market shock assumptions for the Trading BHCs, raise the question of whether the Final CCAR Rule will be (and is designed to be) a more stringent capital requirement than Basel III on a fully phased-in basis, perhaps even including the G-SIB Surcharge where applicable. Although BHCs would not be “required” to meet the 5 percent Tier 1 common stress test, the apparent prohibition on dividend increases and stock repurchases resulting from a failure to meet this ratio is likely to compel BHCs to achieve that ratio. Whether or not the stress 5 percent Tier 1 common equity ratio requires more Tier 1 common than Basel III or even the G-SIB surcharge, the 5 percent test certainly accelerates the need for capital increases as compared to the Basel III phase-in. The overall tone of the Final CCAR Rule and Instructions suggests that the Federal Reserve may very well constrain dividend increases and stock repurchases for at least the near future.

Although the Final CCAR Rule clarified certain aspects of the Proposed CCAR Rule, important questions regarding the application and impact of the Final CCAR Rule remain unanswered:

Compliance with Basel III. The Federal Reserve expects Covered BHCs to demonstrate in their capital plans that they can “readily and without difficulty” satisfy the ratios under the Basel III capital framework as they come into effect. As indicated above, it remains to be determined how the various Basel III related guidance will be implemented in practice.

Impact on Acquisitions. As discussed above, “material changes” in a Covered BHC’s risk profile trigger a requirement under the Final CCAR Rule to resubmit a Covered BHC’s capital plan, and, while its plan is being reviewed, the Covered BHC must obtain the Federal Reserve’s prior approval before making any capital distribution. Because some larger acquisitions may cause a “material change” in a Covered BHC’s risk profile, acquisitions may have a disruptive effect on a Covered BHC’s capital plan and planned capital distributions. As a consequence, the Final CCAR Rule may affect new acquisitions by Covered BHCs.

Application to Non-Bank Financial Firms. The Final CCAR Rule by its terms only applies to U.S. BHCs. It remains to be determined whether the Federal Reserve will, at some point in the future, promulgate a version of the Final CCAR Rule that applies to non-bank financial firms (for example, nonbank financial companies that the Financial Stability Oversight Council determines should be subject to Federal Reserve supervision).

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