Fed Details ‘Too Big To Fail’ Battle Plan

December 20, 2011 | Posted in News

The Federal Reserve proposed a number of measures to enforce tighter regulation and stricter supervision of major banks Tuesday, as well as systemically critical firms that are not technically banks and have traditionally fallen outside the central bank’s purview.

The proposal, mandated by the Dodd-Frank financial reform act, “includes a wide range of measures addressing issues such as capital, liquidity, credit exposure, stress testing, risk management and early remediation requirements,” according to a press release Tuesday.

Banks with consolidated assets of at least $50 billion, as well as nonbank financial institutions “that may be designated by the Financial Stability Oversight Council as systemically important companies,” will be subject to the following conditions:

  • Risk-based capital and leverage requirements. These requirements would be implemented in two phases. In the first phase, the institutions would be subject to the Board’s capital plan rule, which was issued in November 2011. That rule requires firms to develop annual capital plans, conduct stress tests, and maintain adequate capital, including a tier one common risk-based capital ratio greater than 5 percent, under both expected and stressed conditions. In the second phase, the Board would issue a proposal to implement a risk-based capital surcharge based on the framework and methodology developed by the Basel Committee on Banking Supervision.
  • Liquidity requirements. These measures would also be implemented in multiple phases. First, institutions would be subject to qualitative liquidity risk-management standards generally based on the interagency liquidity risk-management guidance issued in March 2010. These standards would require companies to conduct internal liquidity stress tests and set internal quantitative limits to manage liquidity risk. In the second phase, the Board would issue one or more proposals to implement quantitative liquidity requirements based on the Basel III liquidity rules.
  • Stress tests. Stress tests of the companies would be conducted annually by the Board using three economic and financial market scenarios. A summary of the results, including company-specific information, would be made public. In addition, the proposal requires companies to conduct one or more company-run stress tests each year and to make a summary of their results public.
  • Single-counterparty credit limits. These requirements would limit credit exposure of a covered financial firm to a single counterparty as a percentage of the firm’s regulatory capital. Credit exposure between the largest financial companies would be subject to a tighter limit.
  • Early remediation requirements. These measures would be put in place for all firms subject to the proposal so that financial weaknesses are addressed at an early stage. The Board is proposing a number of triggers for remediation–such as capital levels, stress test results, and risk-management weaknesses–in some cases calibrated to be forward-looking. Required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales.

The Fed, which is soliciting comments on the proposal by March 31, is pushing to have banks comply with the enhanced standards within a year of them being finalized, other than the provision for the stress tests  to be made public, which would take effect shortly after the rule is finalized. The central bank is working on a separate proposal for savings and loan holding companies.

Tuesday’s Fed proposal includes most major U.S. financial institutions that are already working up 2012 stress tests due shortly after the New Year. Shares of those firms were on the mend after a rocky session Monday in which the financial sector paced the market’s losses. Bank of America gained 2.6% to climb back above $5; Citigroup 3.8%; JPMorgan Chase 3.8%; Wells Fargo 4.1%; Goldman Sachs Group 3%; and Morgan Stanley 3.5%.

Forbes: By Steve Schaefer


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