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Kevin Fromer

President and Chief Executive Officer

Bank supervision is a longstanding practice intended to ensure we have a safe and sound banking system.&nbsp; Experienced bank supervisors can provide informed and focused feedback to banks, supporting banks’ efforts to operate successfully in a dynamic economy.&nbsp; The benefit of appropriate supervision is clear: a safely-run bank delivers for its customers and communities.&nbsp; What if, however, supervision becomes broken, unfocused, and excessive?&nbsp; Like incorrect or excessive medication, there is an increased risk of adverse side effects.&nbsp; In recent years, the signs of those effects have become increasingly clear and pervasive.&nbsp; Bank supervision has strayed from its core objectives, and banks of all sizes are experiencing those side effects.&nbsp; The results are not good, and they ironically may be reducing safety and soundness.&nbsp; Given the critical importance of the banking system to our nation’s shared prosperity and growth, we need to get back to a rigorous but sensible approach to bank supervision and we must not wait.Four broad changes must be vigorously pursued to bring supervision back to its core mission: focus on material risks, respect the boundary between supervision and regulation, provide for effective challenge, and improve efficiency in supervision.&nbsp;&nbsp;<h3>Getting Back to the Core Mission: Restore Focus on What Matters</h3>Fundamentally, the objective of supervision is to ensure that banks operate in a safe and sound manner.&nbsp; Supervisors review the activities of banks and assess whether the firms are complying with laws, a raft of regulation and other guidance.&nbsp; They also assess whether firms are properly managing risks associated with proper funding (e.g., capital and liquidity), operations (e.g., cyber resilience), and financial crime (e.g., money laundering) to name a few.&nbsp; Outsized risks, if poorly managed, can imperil a bank’s safety and soundness.&nbsp; To be effective, bank regulators must focus their resources on those bank practices that have a clear and material bearing on a bank’s financial risks and soundness.The recent failure of Silicon Valley Bank (SVB), and the resulting reports that detail the failures leading up to its collapse, clearly demonstrates the costs of losing supervisory focus.&nbsp; The Federal Reserve’s <a href="https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf">report</a> on SVB details 31 distinct issues that were flagged by supervisors for remediation prior to its failure.&nbsp; Of those 31 issues, a significant majority – 20 out of 31 – fell under the rubric of “Governance and Controls”.&nbsp; Governance and Controls covers a range of largely process-driven issues that, while not irrelevant, do not relate to the core banking function that drives safety and soundness.&nbsp; A review of the SVB report shows that the Governance and Controls issues identified by supervisors included “data governance,” “vendor management,” and “IT asset management.”&nbsp; Unfortunately, only a relatively small share of supervisory findings related to the core capital and liquidity issues that were at the heart of SVB’s collapse.The lesson learned from SVB cannot be overstated, must not be forgotten, and must inform near-term supervisory reform efforts.&nbsp; Bank supervisors do not have limitless resources.&nbsp; The resources stewarded by bank supervisors must be focused on activities and practices that go directly to a bank’s safety and soundness.&nbsp; In his recent Congressional testimony, Chair Powell reflected on the key problem at SVB.&nbsp; In response to a direct question about SVB, he offered that “what happened was, I would say a lot of focus on process and on governance and controls and not enough focus on basic bread and butter banking, credit risk, liquidity, risk, interest rate risk, things like that.”&nbsp; Bank supervision can be significantly improved and made more efficient by heeding these words and re-focusing supervision on what truly matters.Finally, in fixing one mistake and re-focusing supervision on materiality, it is important not to make another, even more costly mistake.&nbsp; Supervisors should not engage in “Monday morning quarterbacking” of bank decisions.&nbsp; Supervisors should ask questions and seek to understand why bank management makes certain, material risk decisions, but a drive to understand should never be allowed to morph into a drive to supplant bank management.&nbsp; It can indeed be tempting for supervisors to inject their own views considering all the context and information that is being provided as part of the supervisory process, but that temptation must be actively avoided.&nbsp; Supervisors are not bankers and are not in the business of providing “consulting advice” to bankers.&nbsp; Rather, bankers and supervisors must respect the relevant expertise and role of the other party as they work together in the supervisory process.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<h3>Stick to Your Knitting: Respecting the Boundaries Between Supervision and Regulation</h3>Bank supervisors have an important job to do; they are charged with the critical task of assessing whether banks comply with existing regulations supporting bank safety and soundness.&nbsp; Bank supervisors are not charged with making new regulations or otherwise adjusting or tweaking existing regulations based on their views of bank practices.&nbsp; Regulatory staff have a different charge: they devote significant time, attention, and resources to the policy formation process. &nbsp;Their work is subject to public review and comment before implementation.&nbsp; For good reason, regulation is a distinct and separate function from the supervision function and their boundaries must be respected.&nbsp; Supervisory findings may, when subject to appropriate public transparency standards, inform the regulatory process, but supervisory judgement should not replace the existing, open, and transparent policy process. &nbsp;Private guidance or other directions by supervisors that results in a de-facto regulatory change runs counter to long-standing, good public policy and risks reducing the effectiveness of supervision.Much of supervision occurs through observation of practices across a set of banks followed by suggestion and comment.&nbsp; Such “horizontal reviews” of bank practices, when well executed, can be a useful input to the supervisory process.&nbsp; At the same time, using the findings of those reviews to require or vigorously “suggest” policy changes in bank practices provides no opportunity for public review and comment and breaches the boundary between supervision and regulation.&nbsp;<h3>Let’s Go to the Replay Center: Providing for Effective and Non-Contentious Challenge&nbsp;</h3>Professional sports have been transformed over the past 25 years by the introduction of video review.&nbsp; The use of video review reflects the fact that referees are human and make mistakes that they cannot self-identify in real-time by dint of the fact that they are… human.The same issue arises in the case of supervision.&nbsp; Often, there are differing views on complex financial and regulatory issues. For example, did he swat the basketball away before or after it reached its maximum height?&nbsp; In such cases, supervisors should be accepting of and even invite effective challenge.&nbsp; An effective challenge of an existing view requires one to rigorously re-evaluate their position and ultimately improves the quality of the viewpoint and any decision tied to it.&nbsp;Moreover, supervisors often simultaneously play the role of “judge, jury, and executioner”.&nbsp; The supervisory agency is responsible for establishing the rules, supervisors judge adherence to those rules, and the supervisory agency will mete out any penalties or other consequences for any violation of those rules.&nbsp; As a result, it is all the more important that supervisors institute and actively encourage the ability of a firm to challenge a supervisory finding.An effective challenge mechanism would allow firms to seek a third-party review of a supervisory finding or interpretation that it believes to be made in error.&nbsp; To be clear, a third party may be a representative of the supervisory agency but should not be anyone that is directly connected to the issue being challenged.&nbsp; Such reviews must be received in good faith by supervisors and must not come with the fear – real or perceived - of reprisal.&nbsp; The challenge mechanism must be predictable and efficient.&nbsp; The process to escalate and resolve a challenge must be clear to all parties, not subject to change on a whim, and should be concluded within a reasonable timeframe so that things don’t linger interminably.&nbsp;<h3>Making the Trains Run on Time: Elevating the Importance of Efficiency in Supervision</h3>Beyond focusing too much on immaterial matters, the case of SVB also demonstrated that a lack of efficiency and overly cumbersome bureaucracy in supervision can have tragic consequences.&nbsp; In the case of SVB, supervisors did identify the key lack of liquidity risk management that ultimately led to its downfall.&nbsp; Tragically, however, supervisors did not act decisively or deliberately to get ahead of the problem before it was too late.&nbsp; Rather, untold rounds of meetings and briefings were held without providing specific and actionable feedback to SVB management.&nbsp; By the time the liquidity risk crystallized, it was too late to address the long festering problem, and the firm collapsed.This incident should serve as a parable to illustrate a broader truth.&nbsp; Efficiency matters.&nbsp; Sitting on the right answer until it is too late is worse than having no answer at all.&nbsp; More broadly, supervision should be designed at the outset to be effective.&nbsp; Effectiveness means providing feedback in a reasonable time frame and then laying out clear, transparent, and actionable steps that can be taken to address the issue.&nbsp;The supervisory process must be designed to be as efficient as possible.&nbsp; As an example, supervisory communication can often be long and drawn out.&nbsp; Supervisors may conduct an exam and then take several months formulating and processing the results before any feedback is provided to firms.&nbsp; Finally, supervisory findings may not come with clear, actionable steps that can be taken to address the identified issue.&nbsp; Rather, supervisory communication may be too “high-level” or “principles-based” to be of much practical use.A move to greater efficiency in supervisory communication would promote a frank and healthy exchange of views.&nbsp; In the vein of “if you see something, say something”, a quick and direct communication shortly following identification of a supervisory issue is likely to elicit an informed and genuine response as the issue will likely still be top of mind for management.&nbsp; Shrouding each and every communication in an overly elaborate, formal and formulaic response deadens the senses and limits the scope for productive engagement.A re-invigoration of the supervisory process with a drive for greater efficiency will improve the quality and quantity of supervision and firm engagement.&nbsp; With clearer and more transparent communication, signposts, and remediation action steps, firms will realize that they have greater agency and will be incentivized to productively and collaboratively contribute to the supervisory process.&nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<h3>The Road Ahead: How Do We Get Where We Need to Go?</h3>We have laid out four key supervisory reform areas:<ol><li>Refocus supervision to focus on issues of significant materiality to safety and soundness.</li><li>Respect the boundary between supervision and regulation.</li><li>Provide for effective challenge of supervisory determinations.</li><li>Elevate the importance of efficiency in the supervisory process.</li></ol>Each of these changes is critical to reforming bank supervision.&nbsp; Together, these changes amount to a real cultural shift in supervision.&nbsp; Culture change is both notoriously difficult and spectacularly rewarding when achieved.&nbsp; Manifesting a real culture change will require an “all of the above strategy” that seeks to change both informal, internal processes and executive organization of supervision, as well as changes to the regulatory framework that governs how supervision is conducted.In some cases, new regulations are called for to enact the needed changes.&nbsp; Durable changes to a policy regime require formal changes to the “rules of the road” to establish and publicly signal a permanent shift in thinking and behavior.&nbsp; As an example, establishing an effective challenge system is one example where changes to regulations are likely required.But culture does not change by fiat alone.&nbsp; Put differently, you can’t regulate people into thinking differently.&nbsp; To affect a durable and genuine change in supervisory culture, the internal, and necessarily informal, organization and administration of supervision must change.&nbsp; The organization and number of supervisory committees, standards of practice around supervisory examination and communication, and expectations around how supervisors engage with bankers on a day-to-day basis will most efficiently and effectively be reformed by changing internal processes and procedures that reset the cultural baseline that determines “how supervision is done”.<h3>Getting Started: No Time Like the Present</h3>Effective and efficient supervision is critical to the safety and soundness of our banking system, along with the growth and American competitiveness it supports.&nbsp; Our members are committed to working with supervisors to support a safe and sound banking system that works for everyone.&nbsp; The areas of reform detailed above represent common sense changes that would bring focus and efficiency.&nbsp; They are supported by the collective experience of our members as well as the recent example of Silicon Valley Bank.&nbsp; As the collapse of SVB made clear, the conduct of supervision can have a first order impact on bank safety and soundness. Our expectation is that supervisors will immediately begin the process of implementing reforms that will have a durable and positive impact on the banking system and our economy.&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;

BankNotes Blog

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The Forum advocates for appropriate policy and regulation that promotes a strong, diverse financial system and supports the needs of our economy and American competitiveness.

Regulatory, other topics 

The Urgency of Making Bank Supervision Focused, Efficient, and Supportive of Stability and Growth

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Sean Campbell

Chief Economist, Head of Policy Research

<h3>Introduction</h3>As we navigate the start of 2025, it is a good idea to take stock of the state of large bank capital while also considering what reforms are needed to better align capital standards with economic growth.&nbsp; In this post, we document the significant inflation in large bank capital – in both dollar and percentage terms – since 2018.&nbsp; We close by outlining key capital reforms that are necessary to ensure that large banks can continue to support a robust economy while safeguarding a resilient banking system.&nbsp; Finally, the issues that we discuss below are treated in greater detail in our recent report “<a href="https://fsforum.com/a/media/financial-services-forum,-jan-2025.pdf">Observations and Recommendations for a New Administration and U.S. Economic Growth</a>”, and we refer folks to the report for a deeper dive on these issues.<h3>Large Bank Capital is at All-Time Highs</h3>Figure 1 documents the state of bank capital for Forum members.&nbsp; The chart displays a four-quarter average of Forum member aggregate common equity Tier 1 (CET1) capital – the highest quality form of capital.&nbsp; The chart shows both the dollar value of capital maintained by Forum members as well as the aggregate ratio of capital to risk-weighted assets.<figure class="image image_resized" style="width:76.98%;"><img src="https://fsforum.com/a/media/2.5.25-blog-chart.png"><figcaption>Source: Federal Reserve Y9-C</figcaption></figure>As shown in the chart, Forum members now maintain more than $950 billion in CET1 capital.&nbsp; This level of capital is an all-time high.&nbsp; The same pattern is also evident in percentage terms.&nbsp; The aggregate Forum member capital ratio now stands at over 13 percent, also an all-time high.The robust level of capital maintained by Forum members has been clearly recognized by regulators.&nbsp; As an example, the Federal Reserve recently pointed to the strong level of large bank capital among Forum members (U.S. GSIBs) in its <a href="https://www.federalreserve.gov/publications/files/financial-stability-report-20240419.pdf">Financial Stability Report</a>.&nbsp; Specifically, they noted that “CET1&nbsp;ratios for global systemically important banks (G-SIBs) reached the highest levels recorded in the past decade, while CET1 ratios for large non–G-SIBs and other bank holding companies were close to pre-pandemic levels.”&nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<h3>Large Bank Capital Has Been Inflated by Ever-Rising Regulatory Requirements</h3>Considering the all-time high levels of bank capital, it is worth exploring the reason for these capital levels.&nbsp; While Forum members are committed to strong capital levels that support a resilient banking sector and robust economy, they are also subject to the requirements of bank regulators.&nbsp; And, indeed, much of the increase in required capital can be traced to inflated regulatory requirements.&nbsp; In Figure 2 below, we document the change in required capital for Forum members in just the past six years.<figure class="image image_resized" style="width:76.93%;"><img src="https://fsforum.com/a/media/2.5.25-blog-chart-2.png"><figcaption>Source: Federal Reserve Y9-C, FFIEC 101</figcaption></figure>As shown in Figure 2, CET1 requirements have increased from 8.4 percent to 11.2 percent since 2018.&nbsp; Looking further, the chart shows that the rise in requirements is driven by a significant increase in the stress capital buffer, or “SCB,” (1.9 percent to 3.5 percent) that is a result of the Federal Reserve’s stress testing framework as well as a significant increase in the GSIB surcharge (2.0 percent to 3.2 percent).&nbsp; These increases have occurred despite the fact that the risk profile of Forum members has improved.In the case of the GSIB surcharge, the increase is driven largely by an unwarranted inflation in GSIB surcharges stemming from the massive increase in the Federal Reserve’s balance sheet since 2018.&nbsp; As we have discussed <a href="https://fsforum.com/news/raising-the-cost-of-credit-at-the-wrong-time-the-unnecessary-and-counterproductive-rise-in-the-gsib-surcharge">previously</a>, both paradoxically and perversely, the GSIB surcharge for Forum members continues to increase despite the fact that the expansion of the Federal Reserve’s balance sheet increases the supply of safe bank reserves, which lowers systemic risks.In the case of the stress capital buffer, the increase stems from the replacement of a fixed “capital conservation buffer” with a buffer that increases or decreases based on the potential losses simulated in the annual stress test exercise.&nbsp; This new capital requirement was introduced in 2020.Finally, while it is not displayed in Figure 2, no discussion of large bank capital requirements is complete without mentioning risk-blind leverage capital requirements.&nbsp; As we have <a href="https://fsforum.com/news/past-due-notice-addressing-leverage-capital-for-large-banks-to-restore-treasury-market-functioning">previously</a> discussed, the massive inflation of the Federal Reserve’s balance sheet has made leverage capital requirements increasingly binding and has indirectly led to increased capital levels for large banks.&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;In sum, a primary driver of increased capital among large banks has been an inexorable and unnecessary inflation of large bank capital requirements, which are not supported by any consistent, well-established analysis.&nbsp; The only common thread tying together these developments has been the loose claim that “more is better.”&nbsp; Of course, this claim is fundamentally incorrect as it ignores the fact that increasing capital has a real economic cost.&nbsp; Like any economic resource, unchecked increases, at some point, become counterproductive.&nbsp;<h3>Capital Reform in 2025&nbsp;</h3>Forum members are strongly committed to robust capital standards that are transparent, risk-sensitive, and strike the right balance between safety and growth.&nbsp; Unfortunately, the last several years have witnessed a variety of capital-related policies that have moved us further away from an appropriate and efficient bank capital regime that supports the U.S. economy.&nbsp; The following capital policy initiatives should be undertaken in 2025 to reform and improve the large bank capital regime.<ol><li>Any implementation of Basel III Endgame must be consistent with its original intent, coherent with other capital requirements, and mindful of the robust level of capital maintained by large banks.&nbsp; Basel III Endgame was developed as a means of raising capital standards for non-U.S. banks to closely align with U.S. standards and was not intended to materially increase capital.&nbsp; As described above, U.S. large bank capital is at an all-time high and exceeds the level maintained by foreign peers.&nbsp; Any final implementation of Basel III Endgame in the United States must ensure a level playing field with those of non-U.S. jurisdictions and should not result in any increase in capital for large U.S. banks.&nbsp;&nbsp;</li><li>&nbsp;The GSIB Surcharge must be fundamentally reformed.&nbsp; The U.S. version of the GSIB surcharge is significantly more stringent than the international standard applied to foreign GSIBs.&nbsp; In addition, the U.S. version of the GSIB surcharge mechanically increases for reasons that have nothing at all to do with systemic risk and in some cases increases when systemic risk decreases.&nbsp; The U.S. GSIB Surcharge must be rationalized with the international standard and should not be allowed to increase unabated as the size of the economy or the size of the Federal Reserve’s balance sheet increases.</li><li>Leverage capital requirements must be reformed so that they are appropriate for the current size of the Federal Reserve’s balance sheet.&nbsp; It is well documented and understood that current leverage capital requirements are undermining the market for U.S. Treasuries and other low-risk assets.&nbsp; Indeed, the G30 publicly <a href="https://static1.squarespace.com/static/58d527666a4963244b157400/t/6102d10a888ff15114a6e71d/1627574539757/G30_U.S_._Treasury_Markets-_Steps_Toward_Increased_Resilience.pdf">called</a> upon the Federal Reserve to reform leverage requirements for this reason.&nbsp; Back in 2021, the Federal Reserve publicly <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20210319a.htm">committed</a> to “soon” reconsider leverage capital requirements, but has not done so.&nbsp; Leverage capital requirements must be reformed so as not to serve as the binding capital constraint and to restore incentives to provide much-needed liquidity to the U.S. Treasury market.</li><li>&nbsp;The stress tests must be reformed to provide transparency and reduce volatility in the annual resetting of the SCB.&nbsp; Recently, the Federal Reserve <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20241223a.htm">announced</a> that it will undertake serious reform of the stress testing regime to improve transparency and reduce unwarranted volatility.&nbsp; We support these efforts and will engage further as they unfold in 2025.</li></ol><h3>Conclusion</h3>Capital levels among Forum members are at an all-time high.&nbsp; Forum members support robust capital standards that support a resilient banking sector and a robust economy.&nbsp; Much of the observed increase in capital over the past several years has been the result of unchecked and inflated regulatory standards that have been allowed to increase without being tethered to any analysis or serious consideration of the appropriate path forward.&nbsp; The reforms described above would improve the effectiveness and efficiency of the large bank capital regime, improve international consistency and competitiveness, and support a strong U.S. economy while maintaining a highly resilient banking system.

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Increases in capital requirements would harm American households, businesses, and the broader economy. Regulators must carefully consider the economic impact of higher capital requirements, because they affect the whole economy, not just banks.

Capital, other topics

Large Bank Capital: There is More to Inflation Than the Price of Goods and Services

This week we learned that bank regulators may re-propose their rule to implement the Basel III Endgame in the United States.&nbsp; The potential changes were outlined in a <a href="https://www.federalreserve.gov/newsevents/speech/barr20240910a.htm">speech</a> by Federal Reserve Vice Chair for Supervision Michael Barr and were the first public explanation of the “broad and material” changes announced by him and Fed Chair Powell earlier in the year.As we await a re-proposal, it is worth considering some initial observations.First, it is important to consider the potential capital impact of 9 percent.&nbsp; In a world in which the largest U.S. banks are demonstrably very highly capitalized and strong, and in which the U.K. has announced its Basel III Endgame will result in an impact of less than 1 percent and the EU stands at 5.6 percent, we still fundamentally question why this proposal raises capital for U.S. banks, and why our policymakers would choose that outcome for the U.S. economy.&nbsp; Basel III Endgame was never intended to increase capital requirements. Given the array of strong prudential safeguards that have been enacted over the past 15 years, it is entirely unclear as to why any measurable increase in large bank capital is needed.&nbsp;Second, the process for reconsidering the proposal is an unusual one.&nbsp; We expect to see revisions that have been agreed by the Fed, the OCC, and the FDIC, but we will not see potential revisions of areas that are still being considered. Commenters will have to determine if their concerns were addressed and to what extent, or completely unaddressed.&nbsp; In addition, the re-proposal likely will be complex and lengthy.Third, the original proposal lacked critical economic analysis, including cost-benefit analysis, that is essential for the public to have and consider.&nbsp; Many decisions in the original proposal lacked justification, and for us, defied explanation.&nbsp; Hopefully, a re-proposal will address these serious shortcomings.The most meaningful changes previewed would alter the imposition of higher capital charges for certain credit exposures, equity exposures, and operational risk.&nbsp; What appears to be largely unaddressed, however, are very significant and higher charges for <a href="https://fsforum.com/a/media/basel-iii-endgame-market-making-requirement-threatens-liquidity,-economy,-and-financial-stability.pdf">exposures</a> associated with trading, market making, and underwriting.&nbsp; These activities are already subject to additional, stringent regulation post-financial crisis, including capital requirements.&nbsp; And they are no less important for the wide range of large companies, mid-market businesses, pensions, state and local governments and other institutions, like universities, which use the services of major banks to access capital, invest, grow and contribute to society. These bank customers serve people and businesses across the country, so not addressing these issues could, as experts have found, increase the costs or reduce the availability of the services they provide.In addition, the re-proposal appears to fall short of providing sensible capital requirements for lending to a wide swath of creditworthy businesses in the United States. The proposal of July 2023 provided a lower capital charge to corporates deemed to be “investment grade” if they are publicly traded (think General Motors), but would apply higher capital charges for companies that are arguably equally credit worthy but privately held (think Chick-fil-A).&nbsp; As we have pointed out, there are a relatively small number of publicly traded companies in the U.S., and many more private ones that would be subject to higher capital charges that are not justified by elevated credit risk.&nbsp; The re-proposal would carve out companies that are “regulated entities” like pensions and mutual funds, but everyone else – essentially non-financial companies – would still be subject to a higher capital treatment.&nbsp; There is no connection between whether a company is high risk or low risk and whether it issues publicly traded securities.&nbsp; If the re-proposal affirms this observation, we believe there will be significant interest in further work on this issue.We look forward to reviewing the re-proposal.&nbsp; It is important we get this right.

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Despite the demonstrated strength of the largest U.S. banks, the Federal Reserve, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, on split votes, issued a proposal in July 2023 to increase capital requirements. The proposal offers no reason or justification for material increases in capital requirements and would harm American households, businesses, and the broader economy. 

Given the complexity of the proposal, its many and significant negative impacts, and the lack of evidence in support of its changes, the agencies should repropose the rule and include the motivations, data and analysis that demonstrate the need for proposed changes.

Basel 3 Endgame 

Basel III Endgame: Where Things Stand

<h3>Introduction</h3>In July, the Government Accountability Office (GAO) issued a <a href="https://www.gao.gov/assets/gao-24-106206.pdf">report</a> that examined the scope and quality of regulatory analysis performed by the three banking agencies (FDIC, Federal Reserve, OCC) in promulgating bank regulations.&nbsp; The report found that “the analyses regulators conducted for many of the 22 major capital and liquidity rules (issued 2012–2021) that GAO reviewed did not consistently reflect leading practices.”&nbsp; Further, the GAO also found that “they did not always identify alternative approaches or quantify benefits and costs.”&nbsp; The findings of this report are important in light of the pending Basel III Endgame proposal and deserve significant attention from the public.&nbsp; In this blog, we briefly review the report and its findings, and discuss the implications for the Basel III Endgame capital proposal.<h3>The GAO’s Key Findings and Recommendations</h3>The GAO report is highly detailed and specific, but the key findings in the report can be summarized as follows.First, the prudential agencies’ analysis did not always reflect key elements of good regulatory analysis.&nbsp; Importantly, the report states that the reviewed analyses did not always: 1) establish a baseline by indicating what would happen if the rule were not adopted, 2) consider and evaluate alternatives beyond the proposed regulation, and 3) assess the benefits and costs of a proposed regulation.&nbsp; Each of these elements is a critical aspect of good regulatory analysis that should be included in any rigorous analysis of a proposed regulation.&nbsp;&nbsp;Second, the Federal Reserve and FDIC did not consistently document the regulatory analysis that was conducted.&nbsp; In effect, the analysis that was included in the agencies’ public rulemakings were not “backed up” with any significant or detailed documentation explaining how or why certain conclusions were reached.&nbsp; In describing its finding, the GAO indicated that “the Federal Reserve’s documentation of its regulatory analysis (other than descriptions in Federal Register notices) did not consistently include information that would allow a qualified third party to understand the basic elements of its analysis.”&nbsp; This finding is particularly concerning as it casts doubt on the entire process by which regulatory analysis is conducted and decisions are reached.&nbsp; Put simply, if analysis is not sufficiently documented so that a qualified third party can understand how conclusions were reached, how can those conclusions be relied upon to support durable regulatory policy?Third, the agencies performed few retrospective reviews.&nbsp; In assessing whether a regulation is appropriate, it is critical to analyze the regulation on both a prospective and retrospective basis.&nbsp; Prospective reviews are critical, but are also, by their very nature, uncertain.&nbsp; Often, the impact of a rule will depend on future events that are difficult to forecast.&nbsp; This is where good retrospective analyses come into play.&nbsp; After a rule has been in place for a significant period of time, regulators should consider the impact of the rule as a means of cross-checking the initial prospective analysis.&nbsp; Such analyses have the potential to identify key areas for improvement that would have been difficult to identify before the regulation was put in place.As a result of these findings, the GAO made two specific recommendations to the Federal Reserve and OCC (no recommendations were made to the FDIC).<ol><li>Policies and procedures for consistently performing regulatory analyses that align with leading practices, including for documenting analyses, should be developed and implemented. (Recommendation made to the Federal Reserve)</li><li>Policies and procedures for systematically performing retrospective reviews of regulations should be developed and implemented. (Recommendation made to the Federal Reserve and OCC)</li></ol><h3>The Implications of the GAO Report for the Basel III Endgame Proposal</h3>As discussed, the GAO report did not include the Basel III Endgame proposal in its scope, but the GAO’s findings and recommendations are highly relevant to the Basel III Endgame (B3E) proposal.Importantly, as has been noted by a wide array of commenters including public interest groups such as the <a href="https://www.urban.org/research/publication/bank-capital-notice-proposed-rulemaking">Urban Institute</a>, the regulatory analysis contained in the B3E proposal is lacking in several respects, many of which were identified in the GAO report. &nbsp;A key limitation of the B3E proposal is that in many cases, the proposal simply provides no cost-benefit justification for the rule other than an unsupported assertion that the benefits outweigh the costs.&nbsp; As discussed in the GAO report, it is critical that the agencies fully explain the analysis and methods that they use to arrive at their conclusions and that the analysis provide sufficient data so that a qualified third party can ascertain how the conclusions are reached.Recently, Federal Reserve Chair Powell has discussed the possibility of a B3E re-proposal in light of the “broad and material” changes that are expected to be necessary in light of the received comments.&nbsp; In addition to re-proposing the rule, it is critical that any re-proposal of B3E be paired with an extensive cost-benefit analysis that adheres to the standards of good regulatory analysis identified in the GAO report.In order to achieve this result, it will be necessary that the GAO’s recommendations are adopted and fully implemented before any re-proposals are made to ensure that the important shortcomings identified by the GAO are fully addressed.Rigorous and transparent cost-benefit analysis is the hallmark of good, durable policymaking.&nbsp; The GAO report is important because it clearly identifies several key aspects in which banking agency regulatory analysis falls short of the mark.&nbsp; Adopting the GAO’s recommendations and fully implementing them in the context of any B3E re-proposal will help ensure that the resulting proposal is appropriate for the banking sector and the broader economy.&nbsp;&nbsp;The GAO report also identified the need to conduct regular, retrospective reviews of regulations.&nbsp; This finding is directly in line with previous statements of Federal Reserve officials that a “holistic review” of large bank capital standards would be conducted.&nbsp; Despite these statements, however, the B3E proposal was issued without first conducting a holistic, retrospective review of the existing large bank capital framework.&nbsp; The lack of a holistic review is itself highly problematic because of the large number of capital and related reforms that have been adopted since the financial crisis.&nbsp; Ultimately, it is not possible to assess the adequacy of the B3E proposal without first rigorously assessing the state of the current large bank capital framework with a holistic, retrospective review.Finally, the call for more regular retrospective reviews has wider implications well beyond B3E.&nbsp; As a specific example, the Federal Reserve has yet to perform a retrospective review of the GSIB surcharge as it indicated it would do when the rule was finalized in 2015.&nbsp; More broadly, the Federal Reserve has publicly committed itself to retrospectively <a href="https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications.htm">review</a> its monetary policy framework every five years.&nbsp; A similar, rigorous, review of the bank regulatory framework should be performed at a similar frequency.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<h3>Conclusion</h3>The recent GAO report makes important findings that should have a significant impact on the approach that banking regulators take to promulgating regulations.&nbsp; Several of the findings contained in the GAO report are directly relevant to the current B3E proposal.&nbsp; Specifically, the B3E proposal does not adequately quantify the costs and benefits of the proposal, and the proposal was not paired with a holistic, retrospective review of the large bank capital framework.&nbsp; Any future re-proposal of B3E should fully conform with the recommendations of the GAO report.&nbsp; A comprehensive cost-benefit analysis of B3E that holistically accounts for the existing large bank capital framework will result in a more grounded, appropriate and durable capital framework for large banks and the broader economy.&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;

Playing Catch Up on Cost-Benefit Analysis: Regulators Need to Up Their Game on Basel III Endgame

<h3>Introduction</h3>This Spring, Federal Reserve Vice Chair for Supervision Michael Barr gave a <a href="https://www.federalreserve.gov/newsevents/speech/barr20240520a.htm">speech</a> previewing some changes to large bank liquidity regulations that may be proposed by the banking agencies.&nbsp; In particular, the Vice Chair indicated that the “regulatory adjustments we are considering would ensure all large banks maintain better liquidity risk management practices going forward.”&nbsp; The largest banks, however, already maintain heightened liquidity risk management practices.&nbsp; In this post, we review the current requirements for Forum members (U.S. GSIBs), discuss the lack of any nexus between the regional bank turmoil of last Spring and the state of Forum members, and make some recommendations to ensure that any proposed liquidity regulations are appropriately targeted, thoughtful, and, critically, informed by data and analysis.<h3>SVB as a Pretext for Tighter U.S. GSIB Liquidity Regulation: A Shoe That Does Not Fit&nbsp;&nbsp;</h3>The events of Spring 2023 that resulted in the failures of Silicon Valley Bank (SVB) and Signature Bank and stirred turmoil among a variety of U.S. regional banking organizations have been cited on several occasions as evidence that all large banks need tighter regulations for liquidity, or the assets banks have available to quickly meet short-term obligations.&nbsp; Unfortunately, this assertion misapplies the lessons from last Spring and does not recognize the liquidity profile and regulatory framework for U.S. Global Systemically Important Banks, or GSIBs.The failure of SVB, Signature Bank and the turmoil that roiled some regional banks in 2023 had absolutely nothing to do with U.S. GSIBs.&nbsp; SVB and Signature were smaller regional banks that were not subject to the broad and extensive panoply of liquidity regulations that apply to U.S. GSIBs.&nbsp; More specifically, these regional banks, and other banks with similar size and activity profiles, were not and are not subject to:<ul><li>The most stringent form of the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR)</li><li>Resolution-based liquidity requirements (RLAP, RLEN)</li><li>A supervisory liquidity oversight program through the Federal Reserve’s Large Institution Supervision Coordinating Committee (LISCC) – only U.S. GSIBs are covered by the Federal Reserve’s <a href="https://www.federalreserve.gov/supervisionreg/large-institution-supervision.htm">LISCC supervisory program</a>.</li></ul>These requirements represent much more than an inscrutable regulatory alphabet soup.&nbsp; The extreme focus on U.S. GSIB liquidity since the financial crisis has had a transformative effect on the liquidity profile of U.S. GSIBs.&nbsp; To wit: consider the following chart and commentary from the Federal Reserve’s most recent Financial Stability <a href="https://www.federalreserve.gov/publications/files/financial-stability-report-20240419.pdf">Report</a>.<figure class="image"><img src="https://fsforum.com/a/media/8.8.24-blog.png"></figure>In particular, the Federal Reserve said regarding High Quality Liquid Assets (HQLA), “U.S. GSIBs continued to hold more HQLA (liquid assets) than required by the LCR – the requirement that ensures banks hold sufficient HQLA to fund estimated cash outflows for 30 days during a hypothetical stress event.”&nbsp; As the chart, and the statement in the Financial Stability Report clearly show, U.S. GSIBs maintain ample liquidity that is well ahead of other U.S. banks.&nbsp; In the face of such clear and unambiguous data, it is difficult to fathom why regulators would think that U.S. GSIBs require even stricter liquidity requirements.&nbsp;&nbsp;&nbsp;Finally, two specific events that unfolded during last year’s regional banking turmoil clearly demonstrate the liquidity strength of Forum members.&nbsp; First, as documented in <a href="https://libertystreeteconomics.newyorkfed.org/2023/05/bank-funding-during-the-current-monetary-policy-tightening-cycle/">research</a> conducted by the Federal Reserve, Forum members actually gained deposits during this period as households and businesses sought the safety and stability provided by Forum members with their high levels of capital, liquidity and overall resilience.&nbsp; Second, amid the unfolding turmoil, Forum members were called upon to help stabilize another struggling bank, First Republic, and contributed the majority of a $30 billion <a href="https://www.bankingdive.com/news/largest-banks-deposit-30b-in-ailing-first-republic-bank-JPmorgan-SVB-Wells-Fargo-contagion/645270/">liquidity injection</a> to First Republic to provide regulators more time to resolve the failing bank.&nbsp;The strong liquidity profile of Forum members as well as the actual events of Spring 2023 clearly indicate that U.S. GSIBs do not have any liquidity problems requiring redress.&nbsp; Rather, Forum members are a source of liquidity strength and resilience that supported the banking sector and the entire economy during that challenging period.&nbsp; Accordingly, any suggestion that the events of SVB “clearly show” a need for more and tighter liquidity regulation for Forum members is plainly inconsistent with the clear and incontrovertible facts from that event.<h3>A Way Forward on Liquidity Regulation</h3>Vice Chair Barr’s speech clearly indicates that regulators are preparing to suggest some important changes to bank liquidity regulation.&nbsp; The issues that regulators are considering are quite complex and would impact the entire economy.&nbsp; Accordingly, regulators should be committed to getting it right rather than getting it done.A precondition to getting it right is clearly defining the problem to be solved with due regard for differences in the state of liquidity profiles and liquidity regulation across the banking sector.&nbsp; Accordingly, before any new liquidity regulations are proposed, banking regulators should release a data-based, comprehensive analysis of the existing liquidity regulatory framework that clearly identifies the specific problem that needs to be addressed.&nbsp; Importantly, the report should clearly account for the graduated stringency of regulation that is applied to larger and larger banks with Forum members being subject to the most stringent liquidity requirements.&nbsp; The analysis and data used to arrive at its conclusions should be available for public comment.&nbsp;Recently, the banking sector has dealt with a capital proposal that was subsequently followed by a data collection that is being used to further define and refine the policy proposal.&nbsp; This approach has raised several legitimate and difficult to cure process concerns that should be avoided in the context of any future liquidity proposals.&nbsp; These process concerns can be squarely addressed by taking a systematic, thoughtful, and data-based approach to liquidity regulation that clearly communicates the specific problem at hand before any proposals are issued.&nbsp;&nbsp;Following the release of the analysis and a review of the comments, regulators may come to the view that changes to the liquidity regime are warranted.&nbsp; If that is the case, banking regulators should begin by first issuing an Advanced Notice of Proposed Rulemaking (ANPR).&nbsp; An ANPR is often used by regulators to thoughtfully engage with the public and seek information prior to issuing a specific proposal.&nbsp; The use of an ANPR gives regulators the opportunity to gather data and information that can be helpful in calibrating a regulatory proposal.&nbsp; Such public engagement is a hallmark of a deliberate and thoughtful regulatory process that puts “Getting it Right” ahead of “Getting it Done.”<h3>The Federal Reserve Should Put Discount Window Reform Ahead of Any New Regulation</h3>Finally, it is important to consider other important lessons from the recent regional bank turmoil.&nbsp; One clear lesson from the 2023 turmoil is that the Federal Reserve’s discount window is in serious need of reform.&nbsp; The events surrounding SVB revealed that the Federal Reserve’s <a href="https://www.federalreserve.gov/monetarypolicy/discountrate.htm">discount window operations</a> – which allow financial institutions to borrow from the Federal Reserve – have not kept pace with basic advancements in information technology that have transformed our whole economy in the past thirty years.&nbsp; An antiquated and largely manual discount window cannot possibly serve a modern banking system that is defined by sophisticated and highly automated information technologies.&nbsp; The deficiencies of the discount window are so glaring that Congress has offered <a href="https://www.warner.senate.gov/public/index.cfm/pressreleases?id=37CA4518-D604-41DB-B020-C8365668E702">legislation</a> to “reform the Federal Reserve’s discount window for the 21st century economy.”&nbsp; Launching a raft of new liquidity regulations before addressing longstanding and significant problems with the discount window would be a clear case of putting the cart before the horse.&nbsp; The discount window is an integral component of the bank liquidity landscape, so ensuring that it operates efficiently and effectively should be a precondition to any new regulation.&nbsp; &nbsp;A modernized and well-functioning discount window will itself improve bank liquidity throughout the entire banking sector and complement existing bank liquidity regulation.&nbsp;&nbsp;&nbsp; &nbsp;<h3>Conclusion</h3>Increasingly regulators are asserting that the large bank liquidity framework needs repair.&nbsp; The assertion is largely based on the idiosyncratic failure of a few smaller institutions last Spring that bear no resemblance in any way, shape, or form to Forum members.&nbsp; The use of that historical episode as a pretext for more stringent GSIB liquidity regulation is wholly inconsistent with the unambiguous facts concerning the liquidity profile of U.S. GSIBs and that unfortunate event.&nbsp; If regulators are determined to launch an effort to change the existing liquidity regime, they should begin by providing the public with a data-based and comprehensive analysis that clearly identifies the specific shortcomings that need to be addressed.&nbsp; Any subsequent proposals should be preceded by an ANPR to facilitate a deliberate and thoughtful approach to regulation that will prove to be appropriately calibrated and durable. Finally, regulators would do well to turn their attention to addressing clear deficiencies with the discount window before launching a raft of new and unproven liquidity regulations.&nbsp; &nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp; &nbsp; &nbsp;&nbsp;&nbsp;

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The nation’s largest banks are subject to the most stringent liquidity standards among U.S. banks. These standards ensure that the largest U.S. banks have sufficient liquid resources, such as cash, to meet liquidity needs such as when customers withdraw money from their accounts. Since 2009, the U.S. GSIBs have tripled their liquid assets, allowing them to remain strong and continue to lend and support the economy in the face of headwinds.

Liquidity 

Getting It Right Before Getting It Done – Large Bank Liquidity Regulation

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Emma Tong

Research Associate, Policy Research

<h3>Introduction</h3>Since the 2008 Financial Crisis, the implementation of the Global Systemically Important Banks (GSIB) framework has become a crucial aspect of financial regulation.&nbsp; GSIB banks, which comprise all Forum members as well as a significant number of large, foreign banks, are subject to an additional capital requirement known as the “GSIB Surcharge.” &nbsp;The GSIB surcharge depends on a large number of technical, data-dependent indicators that form the basis of a “GSIB Score” that then is translated into a GSIB Surcharge.&nbsp; Since the GSIB framework was introduced, GSIB scores have been measured at a quarterly frequency with GSIB surcharges depending on measured GSIB scores at the end of the fourth quarter.Recently, both the Federal Reserve and global regulators through the Basel Committee on Banking Supervision (BCBS) have proposed increasing the measurement frequency of these technical indicators.&nbsp; Under the proposals, GSIBs would be required to measure these indicators at a daily, rather than quarterly, frequency.Why this change to longstanding and accepted practice?&nbsp; Regulators have argued that GSIBs engage in “window dressing” to influence the level of their capital surcharges.&nbsp; More specifically, regulators argue that GSIBs manipulate the level of these indicators at the end of the fourth quarter to achieve temporarily lower scores and surcharges.&nbsp; The BCBS recently issued a staff <a href="https://www.bis.org/bcbs/publ/wp42.htm">working paper</a> making this claim.&nbsp; Relatedly, prior research from the Federal Reserve Board conducted a related <a href="https://www.federalreserve.gov/econres/notes/feds-notes/how-do-us-global-systemically-important-banks-lower-their-capital-surcharges-20200131.html">analysis</a> claiming that U.S. GSIBs have engaged in “window dressing.”&nbsp; As a result, regulators have taken the view that high frequency, i.e. daily, calculation of indicators and scores will counteract window dressing behavior by banks.&nbsp; &nbsp;&nbsp;In this blog, we explore the evidence in favor of window dressing using U.S. data from 2018-2023 that is relevant to U.S. GSIBs (Forum members).&nbsp; The data do not present a clear, compelling, and incontrovertible case for systematic window dressing by U.S. GSIBs.&nbsp; We discuss these results in the context of related economic forces that may be influencing GSIBs and non-GSIBs alike.<h3>GSIB Surcharge Mechanics, Data and Analysis Framework.</h3>As discussed, the GSIB Surcharge is based on each GSIB’s “GSIB Score” as measured at the end of the fourth quarter.&nbsp; Importantly, the resulting GSIB Surcharge remains in force for at least one year.&nbsp; As a result, if a GSIB were able to lower its score temporarily at the end of the year it would benefit as the resulting lower surcharge would persist until, at least, the following year.The Federal Reserve requires that both U.S. GSIBs and non-GSIBs track and publicly report the indicators that are needed to compute the GSIB score on a quarterly basis.&nbsp; As of the first quarter of 2024, 37 banks – the eight Forum members and 29 additional U.S. banks - are required to disclose these data.&nbsp; In principle, non-GSIBs are required to disclose these data in case one of them grows large enough to become a GSIB.&nbsp; Practically speaking, given the current GSIB framework, non-GSIBs are not anywhere close to qualifying as a GSIB.&nbsp; As a result, these banks have no incentive to manipulate or “window dress” their indicators and resulting GSIB scores because they are not subject to the GSIB Surcharge.&nbsp; Accordingly, non-GSIBs and their GSIB scores serve as a useful “control” to compare against the GSIB scores of GSIB banks.&nbsp; Importantly, behavior that is exhibited by both GSIBs and non-GSIBs alike can’t reasonably be attributed to “window dressing” as non-GSIBs have no window dressing incentives.In the analysis that follows we compare the change in GSIB scores from the third to fourth quarter for every bank included in the GSIB score measurement sample from 2018-2023.&nbsp;&nbsp; &nbsp;&nbsp;<h3>GSIB Score Behavior at the End of the Year: GSIBs and Non-GSIBs</h3>Below, we show the percentage change in GSIB scores between the end of the third quarter and the end of the fourth quarter for both GSIBs and non-GSIBs over the 2018-2023 period.&nbsp; Conceptually, the percentage change in score is a natural and relevant measure to assess whether window dressing is occurring because U.S. GSIBs are more complex and have correspondingly larger GSIB scores than their non-GSIB counterparts.The results of this analysis are presented in Figure 1.&nbsp; In Figure 1 we provide a dashed line at a value of zero for reference and comparison.&nbsp; A value that is below zero indicates that the score is declining at the end of the year, consistent with the window dressing hypothesis, while a value that is above zero indicates a rising GSIB score at the end of the year, which would portend a rising surcharge contrary to the window dressing hypothesis.<figure class="image"><img src="https://fsforum.com/a/media/7.16.24-blog-chart-.jpg"></figure>Source: Federal Reserve Y-15The first observation from the results presented in Figure 1 is that both GSIBs and non-GSIBs alike display a significant number of cases in which GSIB scores rise at the end of the year.&nbsp; If GSIB score management is a key consideration for GSIBs, it is hard to understand why we would see their scores rise at the end of the year as a rising score would only tend to increase the resulting surcharge.&nbsp;Looking further at Figure 1 does show that there are also cases in which GSIB scores decline at the end of the year.&nbsp; At the same time, however, the data also show that non-GSIBs exhibit a number of cases in which GSIB scores also decline at the end of the year.&nbsp; To the extent that both GSIBs and non-GSIBs exhibit declining GSIB scores at the end of the year, it is difficult to attribute this behavior to “window dressing” as non-GSIBs have no window dressing incentives.&nbsp;&nbsp;If window dressing were a clear and obvious driver of GSIB Scores for GSIBs at the end of the year, we would expect the data presented in Figure 1 to show a clear and obvious difference in the end-of-year behavior of GSIBs and non-GSIBs – a smoking gun if you will.&nbsp; The data presented in Figure 1 reveal quite the opposite.&nbsp; Both GSIBs and non-GSIBs alike exhibit variable GSIB scores at the end of the year that sometime increase, sometimes decrease, and sometimes stay the same.&nbsp; The data presented in Figure 1 do not present any clear and obvious differences between GSIB and non-GSIB behavior at the end of the year. &nbsp;<h3>Jumping to Conclusions: Conflating Seasonal Effects with Window Dressing?</h3>As discussed, regulators have taken the view that GSIBs actively engage in window dressing and that a regulatory response is required to counteract this behavior.&nbsp; The data presented above tell a much more nuanced story.&nbsp;As presented above there is no incontrovertible evidence to support the window dressing hypothesis. If window dressing is not the motivation of year-end score movements, it begs the question “then what is?”&nbsp;The end of every year is typically characterized by various seasonal or “calendar” impacts.&nbsp; For example, firms of all kinds engage in extensive tax planning and take a variety of tax-related actions at the end of the year.&nbsp; End-of-year accounting management is also widely practiced across a variety of industries including banking.&nbsp; Finally, firms also typically renew and renegotiate customer and vendor relationships at the end of the year in a way that may have impacts on overall activity levels and end-of-year GSIB scores.&nbsp; Regulator statements that end-of-year GSIB scores are driven solely by window dressing fail to consider the fact that the adjustment to banks’ financial positions at year-end may be motivated by a number of legitimate purposes other than lowering GSIB surcharges.&nbsp;This point is especially important as a conceptual matter.&nbsp; Simply because regulators observe GSIB scores declining at the end of the year at some banks does not mean that they can assume that all observed end-of-year GSIB score variation is the result of window dressing.&nbsp; More broadly, observing behavior consistent with a preconceived hypothesis does not “prove” that notion to be true when a variety of other reasons may explain the same observed behavior.&nbsp; &nbsp;Importantly, the previously described research conducted by the BCBS and Federal Reserve failed to consider other important sources of GSIB score variation beyond their previously maintained “window dressing” hypothesis.<h3>Conclusion</h3>Regulator concerns regarding window dressing of GSIB scores are not unequivocally supported by the data.&nbsp; Using regulatory data on both GSIBs and non-GSIBs reveal several similarities in the end-of-year behavior of GSIB scores across both GSIBs and non-GSIBs alike.&nbsp; The data do not present a “smoking gun” in favor of GSIB window dressing.&nbsp; Moreover, neither these data nor the data analyzed in other regulator analyses identify the specific intent underlying observed GSIB score changes and do not adequately address the potential impact of typical end-of-year calendar effects that are frequently observed across a range of industries.&nbsp; Regulator proposals to substantially increase the cost and burden of GSIB score reporting through daily reporting requirements should more carefully consider the various potential causes of observed GSIB score behavior.

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The Forum supports a review of the GSIB surcharge, a capital requirement that was agreed to internationally, but that U.S. regulators have implemented in a manner that places higher requirements on U.S. banks than that required of foreign competitors. 

Federal regulators have failed to review and adjust the calculation of the surcharge to reflect the inflationary effects of overall economic growth, as they indicated it would when the GSIB surcharge rule was enacted in 2015. Since that time, the surcharges for U.S. GSIBs have increased in large part due to economic growth and inflation, which in no way suggests heightened systemic risk.


GSIB Surcharge 

GSIB Scores and Window Dressing: Where is the Smoking Gun?

<h3>Introduction</h3>Each year, the Federal Reserve conducts a stress test of the nation’s largest banks.&nbsp; The results directly determine their capital requirement.&nbsp; When people hear about the stress tests, they naturally think that the stress test results are driven by measurable, concrete factors that contribute to a bank’s risk profile such as exposures to commercial real estate loans or complex financial instruments.&nbsp; While those things matter, the Federal Reserve’s projections for revenues and expenses also play a critical role.&nbsp; In 2024, projected non-interest expense was the single largest driver of the stress test results for Forum members.&nbsp; Projected expenses are, quite unfortunately, one of the least transparent aspects of the annual stress tests.&nbsp; Moreover, expenses are not themselves drivers of risk in the banking sector that should have a first-order impact on capital requirements.&nbsp; This year’s stress test sheds light on the exceedingly opaque nature of the stress tests that contribute to unnecessary and costly volatility in bank capital requirements.&nbsp; The stress tests would be significantly improved with increased transparency as well as a re-evaluation of the process for projecting revenues and expenses in the stress tests.<h3>Expense Projections and the 2024 Stress Tests&nbsp;</h3>Each year, the Federal Reserve’s stress test projects loan and securities losses over a three-year horizon for the nation’s largest banks.&nbsp; These projected losses are driven by the specific exposures that each bank has on its balance sheet as well as the severely adverse stress scenario that is hypothesized by the Federal Reserve each year.&nbsp; A bank with large exposures to a sector that the Federal Reserve decides will be subject to a large shock in the stress scenario will experience elevated projected losses.&nbsp; These losses should be the key driver of risk that would then inform the results of the stress test.Because the stress scenario is assumed to unfold over a very long, three-year, horizon the stress testing procedure must also project and account for revenues and expenses.&nbsp; Over a three-year period, one can’t simply assume that revenues and expenses are zero as net income before loan loss provisions (revenue less expense) adds to the capital base that is eroded by any projected loan and security losses.Below, we show the change between 2023 and 2024 in the most significant components of the stress tests: income, non-interest expense, loan losses, and trading and counterparty losses.<figure class="image"><img src="https://fsforum.com/a/media/7.9.24-blog-chart.png"></figure>&nbsp;Source: Federal Reserve Board Stress Testing Disclosures: 2023-2024As can be seen in Figure 1, the single largest change in the key stress testing components was a nearly $47 billion increase in non-interest expenses.&nbsp; In addition, income rose by roughly $24 billion while loan losses (provisions) increased by roughly $30 billion, and trading and counterparty losses were effectively unchanged.The data in Figure 1 speak to the significance of expense modeling and projections to the stress tests.&nbsp; Since Friday, June 28, 2024, Forum members have publicly announced that the stress tests will increase their stress capital buffer, or SCB, by roughly 0.4 percent on average.&nbsp; Much of this increase can be traced directly to the increase in projected non-interest expense displayed in Figure 1. &nbsp;&nbsp;Given that a bank’s SCB is an integral component in its overall capital requirement, and that capital requirements at banks have a measurable impact on the broad economy, at this point, we should pause and think a little bit about exactly what is going on here.&nbsp; First, what exactly are “non-interest expenses” and second, do they really have any information content about a bank’s risk level that should inform its capital requirement?<h3>Non-Interest Expenses Explained</h3>As the name suggests “non-interest expenses” are those bank expenses besides interest payments made by banks on their deposits and other debt instruments.&nbsp; As an aside, interest expense is typically not broken out separately, but is considered as part of “net interest income” (interest income less interest expenses).&nbsp; Table 1 below shows the main components of non-interest expense as detailed in Federal Reserve <a href="https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412kovn.pdf">research</a> and also provides a few illustrative examples of non-interest expenses.<figure class="image"><img src="https://fsforum.com/a/media/blog-7.9.24.png"></figure>Source: <a href="https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412kovn.pdf">Federal Reserve Bank of New York</a>As shown in the table above, the most significant category of non-interest expenses is wages and compensation, comprising roughly 50 percent of all non-interest expenses.&nbsp; Following wages, expenses for real estate and other fixed assets, goodwill, and depreciation costs account for the majority of non-interest expenses.&nbsp; At the micro-level, expenses for things like IT, consulting, and legal fees are also contained in non-interest expense.In light of the constituents of non-interest expense, is there any reason to expect these expenses would be a driver of risk in the banking sector?&nbsp; Any reasonable analysis would clearly indicate that this is not the case.&nbsp; Accordingly, it is hard to understand how the single largest driver of the 2024 stress test results could stem from an increase in costs associated with things like consulting fees, real estate expenses, and the like.Finally, one last conceptual issue with projected non-interest expenses.&nbsp; Apparently, the stress tests assume that non-interest expenses will rise in a stress event.&nbsp; But roughly half of non-interest expense is accounted for by wages.&nbsp; In a period of financial stress, wages are likely to fall and not rise as financial activity grinds to a halt.&nbsp; Even if wages don’t rise, the idea that they would increase markedly is counter to any standard economic theory of supply and demand in the labor market.&nbsp;&nbsp;&nbsp;<h3>Stress Testing Opacity and Non-Interest Expense</h3>As discussed, non-interest expenses are projected in the stress tests due to the very long, three-year, horizon of the hypothesized stress scenario.&nbsp; How exactly then are these expenses projected?&nbsp; The short answer is that nobody, except Federal Reserve staff, knows the answer to that question.&nbsp; Moreover, if loan or security losses are projected to increase, one can at least observe whether a bank has a rising exposure to those assets or whether the scenario posits a particularly challenging economic environment for such assets – as in sharply declining commercial real estate prices.&nbsp; In the case of non-interest expenses, what specific economic indicia would portend sharply rising wages, consulting fees, real estate costs, or IT costs?&nbsp; These sorts of costs are largely unrelated to financial and economic risk, suggesting that the related projections in the stress tests are largely discretionary without being tied to any clear indicators of risk or distress.&nbsp; The resulting projections then naturally result in overly volatile stress test results unrelated to financial risk.&nbsp;On June 26, 2024, the House Financial Services Subcommittee on Financial Institutions and Monetary Policy held <a href="https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=409298">a hearing</a> entitled “Stress Testing: What’s in the Black Box.”&nbsp; In that hearing, the <a href="https://fsforum.com/news/stress-test-process-needs-to-be-more-transparent">Forum</a> and several other experts testified on the concerning nature of an opaque regulatory process that levies capital requirements using non-public, quantitative models that cannot be reviewed, examined, or audited by the public.&nbsp; This year’s round of stress tests adds another clear data point underscoring the urgent need for greater transparency in the stress tests.&nbsp; When stress test results and resulting capital requirements are driven by opaque projections for expenses largely unrelated to financial risk, the entire basis for stress testing is called into question.<h3>Conclusion</h3>The increased severity of this year’s stress test results are being driven by opaque projections for certain expenses that are not generally tied to any reasonable notion of financial risk.&nbsp; As a result, we are witnessing an injection of regulatory volatility via undisclosed and opaque models into regulatory capital requirements that do not serve the public interest.&nbsp; The stress tests should be reformed to be more transparent to the public so that policymakers and the broader public can evaluate whether the stress tests reasonably and realistically assess the riskiness and capital adequacy of our nation’s largest banks.&nbsp;

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Each year, the Federal Reserve tests the ability of large banks to continue to support the economy even in the face of a severe recession far worse than that experienced during the financial crisis.

Multiple hypothetical stress tests, as well as the real-life stress tests of the pandemic and the 2023 regional banking turmoil, have shown that the largest U.S. banks can – and do – act as a bulwark for the economy and the financial sector.

Stress Tests

The Blackest of Black Boxes: The Role of Projected Expenses in the 2024 Stress Test

<h3>Introduction</h3>In a recent Brookings <a href="https://www.brookings.edu/articles/reconsidering-the-regulatory-uses-of-stress-testing/">paper</a>, former Federal Reserve Gov. Daniel Tarullo discussed several potential policy changes to the stress testing regime.&nbsp; Each of the proposals would reduce the transparency of the bank capital regime and inject unwarranted and counterproductive uncertainty into the bank capital process.&nbsp; In this post, we discuss the issue of transparency in the stress tests and comment on the policy changes reviewed in the paper. &nbsp;<h3>Transparent Regulation is a Hallmark of Good Government and Good Capital Policy</h3>In his paper, Daniel Tarullo takes a dim view of transparency in the stress testing process and equates a call for transparency with efforts to “lobby for less dynamism in stress testing.”&nbsp; This claim only seeks to divert attention away from the simple fact that reduced transparency in government regulation is harmful to everyone.&nbsp; It is often said that “sunlight is the best disinfectant” and that a government that operates in the light of day is subjected to vigorous oversight that limits the exercise of arbitrary authority.&nbsp; The notion that the stress tests and financial stability stand to benefit from less and not more transparency stands in clear opposition to decades of experience and common standards of good governance.There is an unstated assumption embedded in the call for less transparency that if banks respond to the design of the stress tests, then they are “cheating.”&nbsp; This viewpoint portrays a deep, serious, and dangerous misunderstanding of how and why banks respond to capital regulation.&nbsp; Bank capital requirements are regulatory pronouncements about risk.&nbsp; Bank assets that are riskier require greater capital to withstand potential losses.&nbsp; Banks respond to capital requirements by trading off the economic benefit of holding the asset with the risk incurred by holding it.&nbsp; If an asset’s risk – either real or as perceived by regulators through capital requirements- increases, then banks have an incentive to reduce their holdings.&nbsp; When a bank engages in this practice it is typically considered good risk management rather than cheating.&nbsp;Moreover, this is exactly the dynamic that is created by existing risk-based capital requirements, or so-called “point-in-time” requirements.&nbsp; If a regulator’s assessment of housing risk results in an increase in housing-related regulatory capital requirements, as has happened in the context of the recent <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20230727a.htm">Basel 3 Endgame</a> capital proposal, banks should re-evaluate the tradeoff between the risk and return of holding housing assets.&nbsp; This is how banks manage their risk while allocating bank funding to its most productive use.&nbsp; Indeed, this very fact coupled with the fact that Basel 3 Endgame’s proposed changes are fully transparent has generated quite a lot of useful public comment that will positively impact the final regulation.&nbsp; Much the same would be achieved if the stress tests were subject to the same degree of public transparency.Oddly, there appears to be a belief that adapting to capital regulation in the context of “point-in-time” requirements is fine, but doing so in the context of dynamic capital requirements via stress tests is not.&nbsp; This is incorrect.&nbsp; Banks should respond to capital requirements and risk whether they be static or dynamic.&nbsp; Imagine that a particular coastal area becomes more prone to flooding because of recent beach erosion but insurance companies are not allowed to raise flood insurance premiums and home builders are required to continue building in the area.&nbsp; This would be crazy.&nbsp; Obviously, as conditions change, affected parties judiciously managing their risk should adapt.&nbsp; The notion that this basic truth is reversed in the case of bank capital stress tests is without any logical basis.<h3>More Opacity in Stress Testing Will Not Improve the Stress Tests</h3>Several of the policy options discussed in the paper would increase the opacity of the stress testing regime.&nbsp; Adding more opacity to the stress tests will not improve their ability to measure capital adequacy.&nbsp;Consider the policy option of including “second round effects” in the stress tests.&nbsp; Second round effects encompass a wide array of highly speculative economic impacts that could, hypothetically, be triggered by significant losses in the banking sector.&nbsp; One such example is the idea that significant bank losses would precipitate a wave of asset “fire sales” by banks that would then further depress asset prices and further erode bank capital.Such impacts are an interesting theoretical possibility but are far – far as in lightyears away– from being settled economic science.&nbsp; Economic modeling is quite unlike Newtonian physics.&nbsp; There are no clear and predictable relationships that are observed regularly with high precision that are backed by clear and (nearly) incontrovertible theories.&nbsp; Our ability to predict and model such “second round” impacts is little more than slightly informed guesswork not rooted in any definitive empirical or theoretical body of research.&nbsp; Rather, the inclusion of any such effects would be mere story telling by the unchecked dictate of Federal Reserve staff without any independent oversight on their modeling.&nbsp; Frankly, economists have quite enough trouble accurately estimating the immediate and direct (first round) impact of economic stress on bank capital levels.&nbsp; The idea that we should further complicate that exercise by including fanciful tales about what may or may not happen because of second or third round effects is a dangerous idea that would threaten the validity and empirical rigor of the stress tests. &nbsp;&nbsp; &nbsp; &nbsp;What would be achieved by adding such speculative impacts to the stress tests?&nbsp; More regulatory uncertainty and unchecked discretion thereby allowing regulators to unilaterally determine capital levels without having to explain or justify the rationale for their determinations.&nbsp; If capital is perceived as being too low, just go ahead and fire up the staff’s “fire sale scenario machine” and presto-change-o, new and higher bank capital! &nbsp; &nbsp;The paper discusses similar policy initiatives along the lines of allowing Federal Reserve staff to make frequent and undisclosed changes to the underlying statistical loss models that drive the stress testing process.&nbsp; Imagine such an approach being applied in any other regulatory context.&nbsp; For example, imagine that the government could simply decide to change the rule by which personal or corporate income taxes are determined without revealing these changes to the public.&nbsp; Or imagine that automobile safety standards were changed by the government without informing auto manufacturers of these changes so they could adapt to the new standards?&nbsp; These examples make clear that allowing for undisclosed and unchecked changes to the bank capital regime would only create chaos and frustrate banks’ ability to understand the regulatory landscape, which would impair their ability to channel resources to their highest and best economic use.&nbsp;<h3>Decoupling the Stress Tests from Capital Requirements: Unhelpful Policy Ping Pong</h3>Another policy option discussed in the paper, suggests that the link between the stress tests and capital requirements, that was implemented by the Federal Reserve in 2020 through the stress capital buffer (SCB) rule, should be abandoned.&nbsp; This policy proposal is highly problematic for two reasons.First, such a change would result in the sort of policy ping pong that typifies bad policymaking.&nbsp; Prior to the SCB rulemaking, the stress tests did not have a transparent and well-defined impact on bank capital requirements.&nbsp; At the time, then Governor Tarullo touted the SCB as a means of simplifying and streamlining the bank capital regime while clearly linking capital requirements to the results of the stress tests.&nbsp; Undoing all of that now would simply create more uncertainty in the regulatory process. &nbsp;Surely, ripping the stress tests out of the bank capital framework now would only invite some future policymaker to graft them back on.&nbsp; An ongoing and torturous cycle of – this year they’re in and next year they’re out until they are back in again would wreak havoc on the bank regulatory regime without offering any benefit.&nbsp; Year-to-year gyrations in capital rules generated by needless policy vacillation wouldn’t do anything but create a confused and ineffective regulatory system.Second, de-coupling the stress tests from capital requirements would only invite the sort of secretive “shadow regulation” that endangers the transparent and equitable administration of government. &nbsp;If the stress tests are not part of the formal capital regime that are governed by strict transparency standards, the stress tests could be used as a supervisory cudgel to achieve capital levels that could not otherwise be achieved through consistent and transparent capital regulation.&nbsp; This possibility would be even more likely if the stress tests could be changed and adjusted as regulators see fit without any public oversight.&nbsp; Open and transparent regulation is important to ensure that regulation is always applied consistently regardless of the prevailing winds of the moment.<h3>Conclusion</h3>Transparency in all forms of regulation and government administration is a long held and widely accepted standard of good governance.&nbsp; There is no compelling argument to abandon this transparency principle in the case of bank capital requirements and the stress tests.&nbsp; Banks must understand the capital rules to which they are subject so that they can appropriately allocate funding to its highest and best use for the economy.&nbsp; A regulatory capital regime that purposefully obfuscates the rules will only reduce the ability of banks to effectively allocate capital while creating counterproductive and dangerous policy uncertainty. &nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;&nbsp; &nbsp;&nbsp;&nbsp;

Stress Testing and Star Chambers: Reducing Transparency Will Not Improve Stress Testing 

<h3>Introduction</h3>In a recent Brookings <a href="https://www.brookings.edu/articles/reconsidering-the-regulatory-uses-of-stress-testing/">paper</a>, former Federal Reserve Governor Daniel Tarullo claims that the stress tests have become less “dynamic.”&nbsp; In this post we investigate this claim by analyzing both the inputs and the outputs of the stress testing process.&nbsp; Our data analysis does not support the claim that the stress testing process has become less dynamic in recent years. &nbsp;&nbsp;Relatedly, we address the oft quoted claim that the move to embed the stress tests into the capital regime through the stress capital buffer (SCB) rule reduced capital requirements for Forum members.&nbsp; Quite to the contrary, the Federal Reserve’s own analysis clearly demonstrates that changes made to the stress testing regime as part of the stress capital buffer rulemaking increased required capital for Forum members.&nbsp;<h3>“Dynamism” in the Stress Tests</h3>Daniel Tarullo’s paper opens by claiming that “over time, these factors have made the stress testing regime, and thus the capital requirements coming out of the CCAR and SCB processes, less dynamic and more predictable – that is something closer to a variation on point-in-time capital requirements.”The paper offers little in the way of direct, data-based evidence to support the claim and that may simply be because it’s not entirely clear what it means for the stress tests to be less “dynamic” and more “predictable.”&nbsp;&nbsp; For example, is the concern that the stress tests take place at regular intervals or rely on a consistent set of data, models, and processes to produce the results?&nbsp; Is it because the stress testing process has been formally included as part of rule-based and transparent capital regulation?&nbsp;&nbsp; All of those aspects of the stress testing regime are indeed “routine” and “predictable,” but they are also the hallmark of good, transparent government regulation that is regularly practiced across an array of regulatory contexts whether it be the regulation of banks, airlines, or automakers.To further assess the claim, we have reviewed publicly available data on the annual stress tests between 2011-2023.&nbsp; We assess the dynamism of the stress tests in two specific, and data-based ways.&nbsp; One approach considers the key inputs to the stress tests while the other considers the outputs of the stress testing process.&nbsp;On the input side, we consider the variability in key stress test scenario variables: US Real GDP, EU Real GDP, Unemployment Rate, Stock Prices, House Prices, CRE Prices, Stock Market Volatility, Yield Curve Slope, and BBB Corporate Bond Yields.&nbsp; These are the key macroeconomic scenario variables that are inputs to the stress tests and are under the direct control of the Federal Reserve Board.&nbsp; A less dynamic stress test would be one in which the variability in these key variables declined substantially over time.&nbsp; As an example, if the Federal Reserve stated that the stock market declined (peak to trough) by 50 percent in each stress test, then that would certainly be less dynamic and more predictable.&nbsp; Banks would understand that in the upcoming year’s stress test the scenario will feature a 50 percent stock market decline.&nbsp; Alternatively, a situation in which the scenario’s stock market decline varied consistently from one year to the next - a decline of 40 percent in one year, 50 percent in another and 35 percent in yet another would demonstrate a consistent and healthy amount of dynamism in the stress test’s key inputs.&nbsp; We assess this measure of dynamism by comparing the standard deviation in the peak to trough scenario path for each of the aforementioned scenario variables over two periods: 2011-2016 and 2017-2023.&nbsp; A finding that the volatility of scenario paths had declined significantly in the later period would signal a decline in dynamism.<figure class="image"><img src="https://fsforum.com/a/media/sean-chart-for-dynamism-blog-7.3.24.png"></figure>Source: Federal Reserve Stress Testing Disclosures: 2011-2023In Figure 1, we present the ratio of the volatility of scenario paths for each key stress test variable over the 2011-2016 and 2017-2023 time periods.&nbsp; A value of 1.0 means that the scenario path was just as volatile in the 2011-2016 period as it was during the 2017-2023 period.&nbsp; A value larger (smaller) than 1.0 means that the scenario path became more (less) volatile over the 2017-2023 period relative to the 2011-2016 period.&nbsp; As shown in the Figure, stress scenario volatility is somewhat mixed.&nbsp; Some variables, such as EU Real GDP and BBB Corporate Bond Yields are significantly more volatile in the later period than the earlier period while other variables such as CRE Prices, Stock Prices, and the Unemployment Rate are somewhat less volatile in the later period.&nbsp; Averaging across all variables shows that stress scenario variables are more volatile (1.36) now than they were in the past.&nbsp; Accordingly, a case can be made that the Federal Reserve’s stress scenario process has indeed become more dynamic in recent times.&nbsp;&nbsp;&nbsp; &nbsp;On the output side, we consider the variability in the results of the stress tests.&nbsp; The easiest way to assess output variability would be to compare the variability in stress capital buffers (SCBs) from one year to the next.&nbsp; Given the SCB was first implemented in 2020, we only have a small time series of SCBs so we consider a useful proxy – the ratio of each bank’s stress test losses (losses net of income) to its risk weighted assets.&nbsp; As before, a stress testing regime in which all banks are converging to a constant loss ratio (SCB) – say 4 percent - from one year to the next would signal reduced dynamism while a regime that shows significant variation from one year to the next, 4 percent in one year, 3 percent in another and then 4.5 percent would indicate a healthy degree of dynamism.<figure class="image"><img src="https://fsforum.com/a/media/sean-chart-for-dynamism-blog-part-2-7.3.24.png"></figure>In Figure 2, we present the volatility in our SCB proxy (net stress test loss/RWA) for each year from 2013-2023.&nbsp; As shown in the chart, the volatility of stress test results hovers around two to three percent from 2013-2023 with no clear and significant pattern either up or down over time.&nbsp; Notably, the volatility is as high in 2023 as it was in 2013.&nbsp; Also, the average stress test loss relative to RWA tends to be about one percent, so a volatility of two to three percent is quite significant.&nbsp; Of course, one may claim that the volatility in stress test losses is simply a product of variation in the population of banks subject to the test – some banks have decidedly different risk profiles and business models than other banks and that results in different stress loss results.&nbsp; That is undoubtedly true, but a more fine-grained analysis of stress losses that controls for bank characteristics would be a significantly more complicated and opaque undertaking that would invite other questions.&nbsp; A perusal of actual SCB results over the past few years supports the finding of this analysis.&nbsp; Just looking at the difference between the <a href="https://www.federalreserve.gov/publications/files/large-bank-capital-requirements-20220804.pdf">2022</a> and <a href="https://www.federalreserve.gov/publications/files/large-bank-capital-requirements-20230727.pdf">2023</a> results shows that changes of 50 to 100 basis points in a bank’s SCB are not uncommon.&nbsp; Against this backdrop, it is puzzling to understand exactly what data, analysis or evidence underpins the claim that the stress tests are becoming less “dynamic.”&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<h3>Changes to the Stress Tests Have Raised Capital Requirements for Forum Members</h3>Another claim referenced in the paper is the view that changes to the stress tests that occurred in connection with the implementation of the SCB rulemaking have reduced capital requirements for Forum members.&nbsp; This claim is demonstrably false.&nbsp; Indeed, the Federal Reserve’s own <a href="https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20200304a1.pdf">analysis</a> regarding the impact of the rule on the Common Equity Tier 1 (CET1) for Forum members clearly stated that “for GSIBs, the largest and most systemically important firms, the draft final rule would lead to an aggregate increase in CET1 capital requirements of approximately $46 billion, on average, a seven percent increase in their current aggregate CET1 capital requirement.”The above point is exceedingly simple and clear.&nbsp; Forum members face higher capital requirements today because of the SCB final rule than they would have faced had the SCB rule not been adopted.&nbsp; Period.&nbsp; End of story.&nbsp; There is no sense in which the SCB rule reduced capital requirements for Forum members.&nbsp; The opposite is true.&nbsp; Of course, some may have hoped that the SCB rule would have increased Forum capital requirements by an even larger amount but that is a different matter altogether.<h3>Conclusion</h3>The Federal Reserve’s stress testing is far from perfect and could benefit from a number of changes to improve its risk sensitivity and transparency.&nbsp; A lack of dynamism, however, is not a problem for the stress testing regime.&nbsp; In this post we analyzed publicly available data on the stress tests from 2011-2023 to quantitatively analyze the claim that the stress tests have become less dynamic over time.&nbsp; Analyzing both the inputs and outputs of the stress tests between 2011-2023 shows no diminution in dynamism over time.&nbsp; Relatedly, the stress tests have also not resulted in lower capital requirements for Forum members.&nbsp; Rather, and quite to the contrary, Forum members’ capital requirements increased as a result of the change to the stress tests that occurred with the implementation of the Federal Reserve’s Stress Capital Buffer rule.

Pairing Words with Analysis:  The Stress Tests are as “Dynamic” Now as they Have Ever Been

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Jane Fraser is the Chief Executive Officer of Citi, the world's most global bank, serving millions of consumers, businesses and institutions across 160 countries and jurisdictions. She is the first female CEO in the firm’s history. Jane has deep experience across Citi’s consumer and institutional businesses and, in many ways, she helped shape Citi into the company it is today. Before becoming CEO in February 2021, she was President of Citi and CEO of the Global Consumer Bank, responsible for all of Citi’s Consumer businesses, including Retail Banking and Wealth Management, Credit Cards, Mortgage and Operations and Technology in 19 markets. Before that, she was the Chief Executive Officer of Citigroup Latin America from 2015 to 2019. From 2013 to 2015, she was the Chief Executive Officer of the U.S. Consumer and Commercial Banking and CitiMortgage. From 2009 to 2013, Jane served as the Chief Executive Officer of Citi's Global Private Bank. Prior, Jane was the Global Head of Strategy and Mergers &amp; Acquisitions for Citi from 2007 to 2009. She joined Citi in 2004 in the Corporate and Investment Banking division. Before joining Citi, Jane was a Partner at McKinsey &amp; Company. She started her career at Goldman Sachs in the Mergers &amp; Acquisitions department in London and then worked for Asesores Bursátiles in Madrid, Spain. Jane serves as a Board Member for the Business Roundtable and the Council on Foreign Relations. She is Vice Chair for the Partnership for New York City and a member of Harvard Business School’s Board of Dean’s Advisors, the Stanford Global Advisory Board and the Economic Club of New York. Jane has an M.B.A. from Harvard Business School and an M.A. in economics from Cambridge University. She is married with two children.

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Jane Fraser

Citigroup Chief Executive Officer, Forum Chair

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Robin Vince is President and Chief Executive Officer of BNY and a member of its Board of Directors. Previously, he was Vice Chair of BNY and CEO of Global Market Infrastructure. In that role, he oversaw BNY’s Clearance and Collateral Management, Treasury Services, Markets and Execution Services and Pershing businesses. Prior to joining BNY in October 2020, Robin was the Chief Risk Officer of Goldman Sachs and a member of the Management Committee. He joined Goldman Sachs in 1994 and held many leadership roles, including Treasurer, Head of Operations, Head of Global Money Markets, COO of the EMEA region and CEO of Goldman Sachs International Bank, among others. He served on several key subsidiary boards and governance committees. He was named managing director in 2002 and partner in 2006. Robin is a member of National Geographic Society's Hubbard Council and serves on the Board of Advisors of The Hospital for Special Surgery.

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Robin Vince 

BNY Chief Executive Officer, Forum Vice Chair

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Bank Of America

Brian Moynihan leads a team of more than 200,000 employees dedicated to making financial lives better for people, companies of every size, and institutional investors across the United States and around the world. Bank of America is recognized as a top employer by Working Mother magazine and Military Times. The company is also listed on Fortune magazine’s list of the Best Workplaces for Diversity and the Best Workplaces for Parents. It was also named one of the Best Places to Work for Disability Inclusion by the U.S. Business Leadership Network and the American Association of People with Disabilities. In 2018, Euromoney recognized Bank of America as the World’s Best Bank and the World’s Best Bank for Diversity and Inclusion, as part of their annual Global Awards for Excellence. Bank of America was also named the 2019 Catalyst Award winner, honored for supporting the continued development, empowerment and advancement of women in the company and around the world. Moynihan participates in several organizations that focus on economic and market trends, including the World Economic Forum International Business Council, the Financial Services Forum, the Bank Policy Institute (chair), the Business Roundtable, and the American Heart Association CEO Roundtable (co-chair). He is also a member of the Federal Advisory Council of the Federal Reserve Board. Moynihan leads the company’s Global Diversity and Inclusion Council and is a member of the museum council for the Smithsonian’s National Museum of African American History and Culture. Moynihan is also a member of the Brown University Corporation’s Board of Fellows and the Congressional Medal of Honor Foundation Board.

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Brian Moynihan

Bank Of America Chairman Of The Board And Chief Executive Officer

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David Solomon is Chairman and Chief Executive Officer and a member of the Board of Directors of The Goldman Sachs Group, Inc. Previously, he was President and Chief Operating Officer and prior to that, he served as Co-Head of the Investment Banking Division from 2006 to 2016. Before that, Mr. Solomon was Global Head of the Financing Group, which includes all capital markets and derivative products for the firm’s corporate clients. He joined Goldman Sachs as a Partner in 1999. Mr. Solomon is a member of the Board of Trustees of Hamilton College and serves on the board of The Robin Hood Foundation.

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David Solomon

The Goldman Sachs Group, Inc. Chairman and Chief Executive Officer

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Jamie Dimon is Chairman of the Board and Chief Executive Officer of JPMorganChase, a global financial services firm with assets of $2.5 trillion and operations worldwide. The firm is a leader in investment banking, financial services for consumers, small business, commercial banking, financial transaction processing and asset management. Dimon became CEO on January 1, 2006 and one year later also became Chairman of the Board. He was named President and Chief Operating Officer upon the company’s merger with Bank One Corporation on July 1, 2004. Dimon joined Bank One as Chairman and CEO in 2000. Dimon began his career at American Express Company. Next, he served as Chief Financial Officer and then President at Commercial Credit, which made numerous acquisitions and divestitures, including acquiring Primerica Corporation in 1987 and The Travelers Corporation in 1993. Dimon served as President and Chief Operating Officer of Travelers from 1990 through 1998 while concurrently serving as Chief Operating Officer of its Smith Barney Inc. subsidiary before becoming co-Chairman and Co-CEO of the combined brokerage following the 1997 merger of Smith Barney and Salomon Brothers. In 1998, Dimon was named President of Citigroup Inc., the global financial services company formed by the combination of Travelers Group and Citicorp. Dimon earned his bachelors degree from Tufts University and holds an MBA from Harvard Business School. He serves on the boards of directors of a number of non-profit institutions including the Clearing House and Harvard Business School. Additionally, he is the Chairman of the Business Roundtable and serves on the executive committee of the Business Council and the Partnership for New York City, and is a member of the Financial Services Forum, Financial Services Roundtable and Council on Foreign Relations.

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Jamie Dimon

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Morgan Stanley

Edward (Ted) Pick is the Chief Executive Officer of Morgan Stanley.Before becoming CEO in 2024, Mr. Pick served as Morgan Stanley's Co-President, Co-Head of Firm Strategy and Head of the Institutional Securities Group, overseeing Investment Banking, Equities, Fixed Income, Global Capital Markets and Research.&nbsp;In previous roles, Mr. Pick was Global Head of Sales and Trading, engineering a turnaround of the firm’s Fixed Income Division. As Head of Institutional Equities, he led that business to a leading global position. He also served as Head of Equity Capital Markets, helping the firm actively raise capital during the financial crisis.&nbsp;Mr. Pick joined Morgan Stanley in 1990 and was promoted to Managing Director in 2002. He is a member of the firm’s Board of Directors (2024), Operating Committee (2012), Management Committee (2008) and Morgan Stanley-MUFG Steering Committee (2013).Mr. Pick graduated Phi Beta Kappa from Middlebury College (1990) and received an MBA from Harvard Business School (1994). He is a Trustee at the Metropolitan Museum of Art (2018), and serves on the MET’s Nominating &amp; Governance Committees. Mr. Pick is Chair of the Advisory Board for the Morgan Stanley Alliance for Children’s Mental Health and a board member of the Institute of International Finance.

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Ted Pick

Morgan Stanley Chief Executive Officer

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State Street Corporation

Ron is chairman and chief executive officer of State Street Corporation. He is also a member of State Street Corporation’s Board of Directors. Ron was previously president and chief operating officer of State Street Corporation, and before that president and chief executive officer of State Street Global Advisors, the investment management arm of State Street Corporation. He joined State Street in 2015. Prior to State Street, Ron was president of Asset Management &amp; Corporate Services for Fidelity Investments, responsible for all Fidelity asset management organizations and Fidelity’s corporate functions and enterprise technology. He served at Fidelity from 2010 to 2014. Prior to joining Fidelity, Ron served as president and chief executive officer of BNY Mellon Asset Management in Boston, a position to which he was named in 2007. During this time, he also served as vice chairman of Bank of New York Mellon Corporation and was a member of its Executive Committee. Additionally, Ron oversaw all of Bank of New York Mellon’s activities in Asia. Prior to the 2007 merger of Bank of New York and Mellon, he was vice chairman of Mellon Financial Corporation and president and chief executive officer of Mellon Asset Management. He served at Mellon and Bank of New York Mellon from 1997 to 2010. Prior to Mellon, Ron was with McKinsey &amp; Company, Inc., from 1986 to 1997 and was elected a partner in 1992. He founded the Investment Management practice worldwide and was co-founder and co-leader of the firm’s North American Personal Financial Services practice. Additionally, he was a member of the Worldwide Property &amp; Casualty Insurance practice. During his tenure with McKinsey, Ron served in the firm’s Boston, New York, and Stockholm offices. Ron received his Bachelor of Arts degree in political science from Syracuse University in 1980 and his Master of Business Administration from Harvard Business School in 1986. Ron serves on the boards of Unum Corp. and Rhode Island Commerce Corporation. He also serves on the boards of Beth Israel Lahey Health, The Boston Foundation, IYRS School of Technology and Trades, Syracuse University and WBUR. Ron’s philanthropic and civic interests include corporate governance, retirement/healthcare policy and funding, education, and climate. He has led several initiatives on gender equality. Ron is a frequent speaker and writer, and an avid offshore sailboat racer.

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Ronald O'Hanley

State Street Corporation Chairman And Chief Executive Officer

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Wells Fargo & Company

Charles W. Scharf is chief executive officer and president, and a member of the Board of Directors of Wells Fargo &amp; Company. A financial services veteran with 24 years of experience in leadership roles in the banking and payments industries, Charlie served as chief executive officer of Bank of New York Mellon from July 2017 to October 2019 and the chairman of its board from January 2018 to October 2018. He also was chief executive officer and a director of Visa Inc. from October 2012 to December 2016. During his tenure at Bank of New York Mellon, Charlie demonstrated a strong track record in initiating and leading change, driving results, strengthening operational risk and compliance, and innovating amid a rapidly evolving digital landscape. As the CEO of Visa, Charlie transformed the firm into a technology-driven digital commerce company by partnering with the world’s leading technology companies to drive new payment experiences and introduce new technologies to improve payment system security. Previously, he was a managing director of One Equity Partners at JPMorgan Chase &amp; Co. and chief executive officer of Retail Financial Services at JPMorgan Chase. He also was chief executive officer of the retail division of Bank One Corp., chief financial officer of Bank One Corp., chief financial officer of the Global Corporate and Investment Bank division of Citigroup, and chief financial officer of Salomon Smith Barney and its predecessor company. Charlie earned a Bachelor of Arts degree from Johns Hopkins University and an MBA from New York University. He is a director of Microsoft Corporation, serves on the board of trustees of Johns Hopkins University, is a member of The Business Council, and is chairman of the New York City Ballet. He lives in New York City.&nbsp;

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