Stress Tests Conducted by BHCs

As noted previously, for the purposes of CCAR, each BHC is required to submit the results of its stress tests based on three supervisory scenarios, at least one stress scenario developed by the BHC, and a BHC baseline scenario. Specifically, a BHC must conduct its stress test for purposes of CCAR using the following five scenarios:

• Supervisory baseline: a baseline scenario provided by the Board under the Dodd-Frank Act stress test rules
• Supervisory adverse: an adverse scenario provided by the Board under the Dodd-Frank Act stress test rules
• Supervisory severely adverse: a severely adverse scenario provided by the Board under the Dodd-Frank Act stress test rules
• BHC baseline: a BHC-defined baseline scenario
• BHC stress: at least one BHC-defined stress scenario

A BHC's estimates of its projected revenues, losses, reserves, and pro forma capital levels must use data as of September 30, 2014; begin in the fourth quarter of 2014; and conclude at the end of the fourth quarter of 2016. The only exception to this planning horizon is with respect to the Regulatory Capital Transitions schedule submission required under the FR Y-14A. The FR Y-14A Regulatory Capital Transitions schedule should be reported as of September 30, 2014, with projections through December 31, 2019, under the supervisory baseline scenario.

In conducting its stress tests, a BHC must reflect the revised capital framework that the Board adopted in connection with implementation of the Basel III accord (revised regulatory capital framework), ¹³ including the framework's minimum regulatory capital ratios and transition arrangements, with one exception: a BHC that is subject to advanced approaches and has exited parallel run is not required to incorporate the advanced approach for calculating RWAs in CCAR 2015.¹⁴ A BHC's stress tests must also reflect the BHC's tier 1 common ratio for each quarter of the planning horizon.¹⁵

Supervisory Scenarios

The supervisory scenarios in CCAR are also used in the Dodd-Frank Act stress tests. Under the Board's Dodd-Frank Act stress test rules, the Board is required to provide BHCs with a description of the supervisory macroeconomic scenarios no later than November 15 of each calendar year.¹⁶

This year, the Federal Reserve intends to provide the supervisory scenarios, including the macroeconomic scenarios and the global market shock, as soon as it is possible to incorporate the relevant data on economic and financial conditions as of the end of the third quarter, but no later than November 15, 2014.¹⁷ It is important to note that the scenarios provided by the Federal Reserve are not forecasts, but rather are hypothetical scenarios to be used to assess the strength and resilience of BHC capital in baseline and stressed economic and financial market environments.

While supervisory scenarios are generally applied to all BHCs that are part of CCAR, the Federal Reserve can apply additional scenarios or scenario components to a subset of BHCs. One component, a global market shock, will be applied to six BHCs with large trading operations in CCAR 2015, as required under the Dodd-Frank Act stress test rules. In addition, the Federal Reserve expects to require certain BHCs to apply a closely related scenario component focusing on the default of a large counterparty.

Global Market Shock

BHCs with large trading operations will be required to include the global market shock as part of their supervisory adverse and severely adverse scenarios, and to conduct a stress test of their trading books, private-equity positions, and counterparty exposures.¹⁸ The global market shock will be applied to BHCs' trading book and private-equity positions, as of a point in time, resulting in instantaneous loss and reduction of capital. The as-of date for the global market shock is October 6, 2014.¹⁹

The global market shock is an add-on component that is exogenous to the macroeconomic and financial market environment specified in the supervisory stress scenarios, and as a result, losses from the global market shock should be viewed as an addition to the estimates of PPNR and losses under the macroeconomic scenario.²⁰ BHCs should not assume a related decline in portfolio positions or RWAs due to losses from the global market shock except in the case noted below.

If a BHC can demonstrate that its loss-estimation methodology stresses identical positions under both the global market shock and the macro scenario, the BHC may assume that the combined losses from such positions do not exceed losses resulting from the higher of either the losses stemming from the global market shock or those estimated under the macro scenario. However, the full effect of the global market shock must be taken through net income in the first quarter of the planning horizon, which will include the as-of date for the shock.

If a BHC makes any adjustment to account for identical positions, the BHC must provide documentation demonstrating that the losses generated under the macro scenario are on identical positions to those subject to the global market shock, break out each of the adjustments as a separate component of PPNR, and describe the rationale behind any such adjustments.

Counterparty Default Scenario Component

Eight BHCs with substantial trading or custodial operations will be required to incorporate a counterparty default scenario component into their supervisory adverse and severely adverse stress scenarios.²¹ Like the global market shock, this component will only be applied to the largest and most complex BHCs, in line with the Federal Reserve's higher expectations for those BHCs relative to the other BHCs participating in CCAR.

In connection with the counterparty default scenario component, these BHCs will be required to estimate and report the potential losses and related effects on capital associated with the instantaneous and unexpected default of the counterparty that would generate the largest losses across their derivatives and securities financing activities, including securities lending and repurchase or reverse repurchase agreement activities. Each BHC's largest counterparty will be determined by net stressed losses, estimated by revaluing exposures and collateral using the global market shock. The as-of date for the counterparty default scenario component is October 6, 2014--the same date as the global market shock.

Similar to the global market shock, the counterparty default scenario component is an add-on component to the macroeconomic and financial market scenarios specified in the Board's supervisory adverse and severely adverse scenarios, and therefore, losses associated with this component should be viewed as an addition to the estimates of PPNR and losses under the macroeconomic scenario (see the description of global market shock).

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BHC Scenarios

A central goal of the capital plan rule is to ensure that large BHCs have robust internal practices and policies to determine the appropriate amount and composition of their capital, given the BHC's risk exposures and corporate strategies and in line with supervisory expectations and regulatory standards.

To gain a deeper understanding of a BHC's unique vulnerabilities, the capital plan rule requires each large BHC to design its own stress scenario that is appropriate to the BHC's business model and portfolios.²² For purposes of CCAR, each BHC will be required to submit the results of its stress tests based on at least one stress scenario developed by the BHC, and a BHC baseline scenario.

The BHC baseline scenario should reflect the BHC's view of the expected path of the economy over the planning horizon. A BHC may use the same baseline scenario as the supervisory baseline scenario if that BHC believes the supervisory baseline scenario appropriately represents its view of the most likely outlook for the risk factors salient to the BHC.

The BHC stress scenario must reflect the specific vulnerabilities of BHC's risk profile and operations, including those related to the company's capital adequacy and financial condition. Specifically, the BHC stress scenario should be designed to significantly stress factors that affect firm-wide material-risk exposures and activities in a coherent and consistent manner, including potential exposures from both on- and off-balance sheet positions. In addition, the forward-looking analysis required in the BHC stress scenario should be relevant to and reflect the direction and strategy of the firm as set by the BHC's board of directors.²³

The BHC stress scenario should be designed to capture potential risks stemming from a BHC's idiosyncratic positions and activities and should be severe enough to result in a substantial negative effect on capital. A BHC should develop a BHC scenario of severity generally comparable to the usual severity in the Board's supervisory severely adverse scenario.²⁴ A BHC should demonstrate that the combined effect of its BHC stress scenario on net income and other elements that affect capital results (i.e., other comprehensive income) in a BHC stress scenario are of severity comparable to the severely adverse scenario. A BHC stress scenario that produced regulatory capital and tier 1 common capital ratios that were lower than those produced in company-run stress tests under the Board's severely adverse scenario, but that does not reflect the BHC's idiosyncratic positions and activities, would not be an appropriate BHC stress scenario.

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Capital Action Assumptions

BHCs must incorporate assumptions about capital actions over the planning horizon into their company-run stress tests. The types of capital actions that BHCs must incorporate into their projections under various scenarios are defined as follows:

• Planned capital actions: a BHC's planned capital actions under the BHC baseline scenario
• Alternative capital actions: a BHC's assumed capital actions under the BHC stress scenario
• Dodd-Frank Act stress test capital actions: capital action assumptions as required under the Dodd-Frank Act stress test rules ²⁵

Planned Capital Actions

As part of the CCAR capital plan submission, for all scenarios except the BHC stress scenario, BHCs should calculate post-stress capital ratios using their planned capital actions over the planning horizon under the BHC baseline scenario.

With respect to the planned capital actions under the BHC baseline scenario:

• For the initial quarter of the planning horizon, the BHC must take into account the actual capital actions taken during that quarter.
• For the second quarter of the planning horizon (i.e., the first quarter of 2015), a BHC that received a non-objection to its 2014 capital plan should include capital distributions consistent with those included in its 2014 capital plan. If a BHC received an objection to its 2014 capital plan, its capital distributions for the second quarter should be consistent with those approved by the Federal Reserve for that quarter.
• For each of the third through ninth quarters of the planning horizon, the BHC must include any capital actions proposed in its capital plan.²⁶

The Federal Reserve will also conduct its post-stress capital analysis using the BHC's planned capital actions proposed in the BHC baseline scenario. (See "Description of All Capital Actions Assumed over the Planning Horizon".)

Alternative Capital Actions

In calculating post-stress capital ratios under the BHC stress scenario, a BHC should use the capital actions it would expect to take if the stress scenario were realized. These alternative capital actions should be consistent with the BHC's established capital policy.

Dodd-Frank Act Stress Test Capital Action Assumptions

For stressed projections under the Dodd-Frank Act stress test rule, a BHC must use the following assumptions regarding its capital actions over the planning horizon for the supervisory baseline scenario, the supervisory adverse scenario, and the supervisory severely adverse scenario:

• For the first quarter of the planning horizon, the BHC must take into account its actual capital actions taken throughout the quarter.

• For each of the second through ninth quarters of the planning horizon, the BHC must include in the projections of capital

  • common stock dividends equal to the quarterly average dollar amount of common stock dividends that the company paid in the previous year (that is, the first quarter of the planning horizon and the preceding three calendar quarters);
  • payments on any other instrument that is eligible for inclusion in the numerator of a regulatory capital ratio equal to the stated dividend, interest, or principal due on such instrument during the quarter;
  • an assumption of no redemption or repurchase of any capital instrument that is eligible for inclusion in the numerator of a regulatory capital ratio; and
  • an assumption of no issuances of common stock or preferred stock, except for issuances related to expensed employee compensation.²⁷

FR Y-14A Summary Schedule Capital Worksheets

BHCs must complete capital worksheets on the FR Y-14A Summary Schedule to report their projections of capital components, RWAs, and capital ratios under each of the five scenarios.

With respect to a BHC's projections under the supervisory scenarios, the BHC must calculate two sets of pro forma capital ratios and complete (1) the CCAR capital worksheet using the BHC's planned capital actions in the BHC baseline scenario, and (2) the DFAST capital worksheet using the prescribed capital actions under the Dodd-Frank Act stress test rule.

For the BHC-defined scenarios, a BHC should include only the CCAR capital worksheet, and include projections using the BHC's expected capital actions as deemed appropriate by the BHC for that scenario and in accordance with the BHC's capital policy.

Table 3 illustrates the capital actions used for each scenario's FR Y-14A schedule.

Table 3. Capital worksheet requirements

Scenario	CCAR capital worksheet	DFAST capital worksheet
BHC baseline	Planned capital actions	n.a.
Supervisory baseline*	Planned capital actions	DFA stress test capital actions
BHC stress	Alternative capital actions	n.a.
Supervisory adverse	Planned capital actions	DFA stress test capital actions
Supervisory severely adverse	Planned capital actions	DFA stress test capital actions

* If a BHC determines the supervisory baseline scenario to be appropriate for its own BHC baseline, the BHC may submit identical FR Y-14A Summary schedules with the exception of the capital worksheets noted above. All BHCs must complete two capital worksheets for the supervisory baseline, supervisory adverse, and supervisory severely adverse scenarios.

n.a. Not applicable.

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References

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