Comprehensive Capital Analysis and Review 2016: Assessment Framework and Results
PrintCapital Plan Assessment Framework and Factors
The Federal Reserve conducted a full review of the capital plans submitted by the 33 BHCs, including both a qualitative assessment of the strength of each BHC's internal capital planning process and a quantitative assessment of each BHC's capital adequacy, each as described below.
Qualitative Assessment
The CCAR 2016 qualitative assessment covered all key areas of BHCs' capital planning process and involved a large number of experts from across the Federal Reserve System, in addition to on-site supervisory teams from each Federal Reserve District with a BHC in CCAR. Federal Reserve System staff involved in the CCAR qualitative assessment included bank supervisors, financial analysts, accounting and legal experts, economists, risk-management specialists, financial-risk modelers, and regulatory capital analysts. This multidisciplinary approach brings diverse perspectives to the Federal Reserve's assessment of the BHCs' capital plans. As in previous years, the Federal Reserve also collaborated with the primary federal banking agencies for the BHCs' subsidiary insured depository institutions, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.
In the qualitative assessment, supervisors focus on the internal practices a BHC uses to determine the amount and composition of capital it needs to continue to function throughout a period of severe stress. The Federal Reserve considers the comprehensiveness of each BHC's capital plan and the extent to which the analysis underlying the capital plan captures and addresses potential risks stemming from firm wide activities.11 The Federal Reserve also evaluates the reasonableness of a BHC's capital plan, the assumptions and analysis underlying the plan, and the robustness of the firm's capital planning process. Where applicable, the assessment leverages existing information about each BHC, such as supervisory findings and information from examinations conducted throughout the year.
The Federal Reserve's qualitative assessment of the capital plans focuses on the extent to which each BHC's internal capital planning process appropriately capture the specific risks and vulnerabilities faced by the firm under stress. The Federal Reserve gave particular attention to the each BHC's material risk-identification process and the development and implementation of the BHC stress scenario to ensure that these processes are effective and appropriately linked to the BHC's firmwide risks.
In December 2015, the Board published two SR letters consolidating its expectations on capital planning:
- SR letter 15-18 "Federal Reserve Supervisory Assessment of Capital Planning and Positions for LISCC Firms and Large and Complex Firms," which provides supervisory expectations for capital planning for firms subject to the Federal Reserve's LISCC framework and other large and complex firms; and
- SR letter 15-19 "Federal Reserve Supervisory Assessment of Capital Planning and Positions for Large and Noncomplex Firms," which provides the supervisory expectations for capital planning for large and noncomplex firms.
SR letters 15-18 and 15-19 explain that the Federal Reserve's expectations for capital planning processes are based on the size, scope of operations, activities, and systemic importance of the firm. In particular, the Federal Reserve has significantly heightened expectations for the largest, most complex BHCs and expects them to have the most sophisticated, comprehensive, and robust capital planning processes.
The financial crisis exposed a number of important weaknesses in the capital planning practices across the largest banks, highlighting that many BHCs had a limited ability to effectively identify, measure, and control their risks and to assess their capital needs. Given the extent of the weaknesses revealed during the crisis, the Federal Reserve has allowed firms some time to work toward full achievement of its high standards for capital planning. Importantly, the Federal Reserve requires the largest BHCs, and in particular those in the LISCC portfolio, to make steady progress each year toward meeting all supervisory expectations and requirements for capital planning. The Federal Reserve closely monitors their progress throughout the year and as part of its annual CCAR program.
The Federal Reserve can object to a BHC's capital plan based on the qualitative assessment. The reasons for a qualitative objection include, but are not limited to, the following: 12
- There are material unresolved supervisory issues;
- The assumptions and analyses underlying the BHC's capital plan are not reasonable or appropriate;
- The BHC's methodologies for reviewing the robustness of its capital planning process are not reasonable or appropriate; or
- The CCAR assessment results in a determination that a BHC's capital planning process or proposed capital distributions would otherwise constitute an unsafe or unsound practice, or would violate any law, regulation, Board order, directive, or any condition imposed by, or written agreement with, the Board.
The Federal Reserve's qualitative assessment focuses on six areas of a firm's capital planning, as set forth in SR letters 15-18 and 15-19: governance, risk management, internal controls, capital policies, scenario design, and projection methodologies.13 (See box 2 for more on the considerations for capital plan qualitative assessments.)
While the comparative analysis supported by evaluating participating BHCs simultaneously allows the Federal Reserve to gain an understanding of relative strengths and weaknesses across the industry, the decision to object or not object to a BHC's capital plan for qualitative reasons is based on an absolute assessment of the effectiveness of each BHC's capital planning processes, in light of the firm's size, scope of activities, and complexity, as well as the progress the firm has made in remediating past deficiencies and meeting the full range of related supervisory expectations. BHCs that receive an objection generally have a critical deficiency in one or more material areas or have significant deficiencies in a number of areas that undermine the overall reliability of the BHC's capital planning process.
Box 2. Considerations for Capital Plan Qualitative Assessments
Material Unresolved Supervisory Issues
The Federal Reserve's qualitative assessment critically evaluates supervisory issues--identified through CCAR and year-round supervisory assessments--related to identification, measurement, and management of firms' material risks and controls and governance around those activities. Sound capital planning requires a strong foundation of risk management, internal controls, and governance more broadly.
The Federal Reserve may object to a firm's capital plan if the firm has material unresolved supervisory issues, including but not limited to issues associated with its capital adequacy process 14 that
- are severe in nature (e.g., relate to the fundamental ability of a firm to identify, measure, and monitor its risks or to determine its capital needs under stressful conditions);
- have proven to be pervasive in nature (e.g., not necessarily confined to an individual function, business line, or assessment area); or
- have remained outstanding for a considerable period of time (e.g., at least one supervisory assessment cycle), with limited progress made in addressing the root causes of the identified deficiencies.
Assumptions and Analysis Underlying the Capital Plan
A forward-looking assessment of capital adequacy under a range of stressful scenarios is a key input to a firm's capital plan. A strong capital adequacy assessment process should clearly link a firm's stress scenarios and its material risks; use sound approaches to quantify the effect of the scenarios on a firm's financial performance and capital positions; critically assess the assumptions, analysis, and output of a firm's stress testing; and be supported by strong controls and governance over the capital planning process.
The Federal Reserve may object to a firm's capital plan if the firm has material or pervasive deficiencies in areas such as
- comprehensive, firmwide risk identification, capture, and measurement, including the identification of risks that may only emerge or become apparent under stress;
- the processes, assumptions, and analysis supporting the development of the firm's stress scenarios and tailoring of those scenarios to the firm's unique risk profile; or
- the assumptions and analysis addressing known data or model weaknesses; accounting for the potential effect of a given stress event on strategic or other management actions; or supporting elements of the forward-looking assessment that remain difficult to model and require business judgment.15
Controls and Governance over the Capital Planning Process
A firm's internal controls over its capital planning process should help to ensure the effectiveness of the firm's capital planning. If a firm has weak internal controls, the reliability and credibility of the firm's capital planning process and any outputs from the process may be compromised.
The Federal Reserve may object to a firm's capital plan if the firm has material or pervasive deficiencies in
- internal controls around key elements of the firm's capital planning processes, including controls around the development and independent validation of key assumptions, models, and other approaches used as part of the firm's forward-looking capital adequacy assessment;
- the execution of internal audits of the firm's capital planning processes;
- data and information technology infrastructure controls supporting the firm's capital adequacy assessment, including those relating to regulatory reporting; or
- senior management oversight of capital planning processes.
Quantitative Assessment
In the CCAR quantitative assessment, the Federal Reserve evaluated each BHC's ability to take the capital actions described in the BHC baseline scenario of its capital plan and maintain post-stress capital ratios that are above the applicable minimum regulatory capital ratios in effect during each quarter of the planning horizon.16 The CCAR quantitative assessment is based on the results of the BHC's internal stress tests under supervisory scenarios and the BHC's own scenarios and post-stress capital ratios estimated by the Federal Reserve under the supervisory scenarios (CCAR supervisory post-stress capital analysis). The Federal Reserve will object to the capital plan of any BHC that has not demonstrated an ability to maintain capital above each minimum regulatory capital ratio throughout the planning horizon in the post-stress capital analysis.
The CCAR supervisory post-stress capital analysis is based on the estimates of net income, total assets, and risk-weighted assets from the Federal Reserve's supervisory stress test conducted under the Dodd-Frank Act.17 (For a comparison of the Dodd-Frank Act stress tests and CCAR, see box 3). As described in the overview of the methodology of the Dodd-Frank Act supervisory stress tests published on June 23, 2016 for these projections, the Federal Reserve uses data provided by the 33 BHCs and a set of models developed or selected by the Federal Reserve.18
The supervisory projections are conducted under three hypothetical macroeconomic and financial market scenarios developed by the Federal Reserve; the baseline, adverse, and severely adverse supervisory stress scenarios.19 While the same supervisory scenarios applied to all BHCs, a subset of BHCs were also subject to additional components in the severely adverse and adverse scenarios--the global market shock and counterparty default scenario components.20 BHCs were also required to conduct stress tests using the same supervisory stress scenarios, at least one stress scenario developed by the BHC (the BHC stress scenario) and a BHC baseline scenario.
As noted above, the Federal Reserve incorporates a BHC's planned capital actions included in the BHC's capital plan under its baseline scenario, including any capital actions associated with business plan changes, in projecting the BHC's post-stress capital ratios. Thus, the BHCs are assumed to maintain the level of dividends and share repurchases they in fact plan to execute over the planning horizon despite the hypothetical severe deterioration in the economic and financial environment. In reality, BHCs could reduce distributions under stressful conditions. However, the goal of the CCAR post-stress capital analysis is to provide a rigorous test of a BHC's financial condition even if the economy deteriorated and the BHC continued to make its planned capital distributions--as many companies continued to do well into the 2007-09 financial crisis.
The Federal Reserve provides each BHC with a one-time opportunity to adjust its planned capital distributions after receiving the Federal Reserve's preliminary estimates of the BHC's post-stress capital ratios. The Federal Reserve considered only reductions in capital distributions, including cutting back planned common stock dividends and/or reducing planned repurchases or redemptions of other regulatory capital instruments, relative to those initially submitted by a BHC in its April 2016 capital plan. These adjusted capital actions, where applicable, were then incorporated into the Federal Reserve's projections to calculate adjusted post-stress capital levels and ratios. The Federal Reserve discloses post-stress results with a BHC's original capital actions and the adjusted capital actions.
Box 3. Dodd-Frank Act Supervisory Stress Tests and the CCAR Post-stress Capital Analysis
While closely related, there are some important differences between the Dodd-Frank Act supervisory stress tests and the CCAR supervisory post-stress capital analysis. The Dodd-Frank Act supervisory stress tests and the CCAR supervisory post-stress capital analysis incorporate the same projections of net income, total assets, and risk-weighted assets. The primary difference between the Dodd-Frank Act supervisory stress tests and the CCAR quantitative assessment is the capital action assumptions that are combined with these projections to estimate post-stress capital levels and ratios.
Capital Action Assumptions for the Dodd-Frank Act Supervisory Stress Tests
To project post-stress capital ratios for the Dodd-Frank Act supervisory stress tests, the Federal Reserve uses a standardized set of capital action assumptions that are specified in the Dodd-Frank Act stress test rules.21 Generally, common stock dividend payments are assumed to continue at the same level as the previous year. Scheduled dividend, interest, or principal payments on any other capital instrument eligible for inclusion in the numerator of a regulatory capital ratio are assumed to be paid. Repurchases of such capital instruments are assumed to be zero. The capital action assumptions do not include issuance of new common stock or preferred stock, except for common stock issuance associated with expensed employee compensation or in connection with a planned merger or acquisition.22 The projection of post-stress capital ratios include capital actions and other changes in the balance sheet associated with any business plan changes under a given scenario.
Capital Actions for CCAR
In contrast, for the CCAR post-stress capital analysis, the Federal Reserve uses a BHC's planned capital actions under its BHC baseline scenario, including both proposed capital issuances and proposed capital distributions, and assesses whether the BHC would be capable of meeting minimum regulatory capital ratios even if stressful conditions emerged and the BHC did not reduce its planned capital distributions. Consistent with this assessment framework, the projection of post-stress capital ratios for CCAR includes capital actions under the baseline scenario, incorporating related business plan changes.
As a result, post-stress capital ratios projected for the Dodd-Frank Act supervisory stress tests often differ significantly from those for the CCAR post-stress capital analysis. For example, if a BHC includes a dividend cut, or a net issuance of common equity in its planned capital actions, its post-stress capital ratios projected for the CCAR capital analysis could be higher than those projected for the Dodd-Frank Act supervisory stress tests.
Return to textReferences
11. 12 CFR 225.8(f)(1). Return to text
12. See 12 CFR 225.8(f)(2)(ii). Return to text
13. See SR letters 15-18 and 15-19, www.federalreserve.gov/bankinforeg/srletters/2015.htm. Return to text
14. See 12 CFR 225.8(f)(2)(ii)(A). Return to text
15. See 12 CFR 225.8(f)(2)(ii)(B). Return to text
16. In CCAR 2016, BHCs were not required to meet the minimum supplementary leverage ratio requirement of 3 percent as part of the quantitative assessment. However, BHCs were required to meet a 4 percent tier 1 leverage requirement. See 12 CFR 225.8(c)(3). In addition, firms are no longer required to meet a 5 percent tier 1 common ratio. Return to text
17. For more on the methodology of the Federal Reserve's supervisory stress test, see Board of Governors of the Federal Reserve Board, "Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results" (Washington: Board of Governors, June 2016), www.federalreserve.gov/newsevents/press/bcreg/bcreg20160623a1.pdf. Return to text
18. For CCAR 2016, in addition to the models developed and data collected by the Federal Reserve, the Federal Reserve used proprietary models or data licensed from certain third-party providers. These providers are identified in appendix B: "Models to Project Net Income and Stressed Capital" of Board of Governors of the Federal Reserve Board, "Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results," (Washington: Board of Governors, June 2016), www.federalreserve.gov/newsevents/press/bcreg/bcreg20160623a1.pdf (see page 53, footnote 35). Return to text
19. BHCs use these scenarios in conducting their company-run stress tests pursuant to the Board's rules implementing section 165(i)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act stress test rules). See 12 USC 5365(i)(2); 12 CFR part 252, subparts F. Return to text
20. The six BHCs that were subject to the global market shock are Bank of America Corporation; Citigroup Inc.; The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; and Wells Fargo & Company. See 12 CFR 252.54(b)(2)(i). The eight BHCs that were subject to the counterparty default component are Bank of America Corporation; The Bank of New York Mellon Corporation; Citigroup Inc.; The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; State Street Corporation; and Wells Fargo & Company. See 12 CFR 252.144(b)(2)(ii). See Board of Governors of the Federal Reserve Board, "2016 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule" (Washington: Board of Governors, January 28, 2016), www.federalreserve.gov/newsevents/press/bcreg/bcreg20160128a2.pdf. Return to text
21. To make the results of its supervisory stress test comparable to the company-run stress tests, the Federal Reserve uses the same capital action assumptions as those required for the company-run stress tests, as outlined in the Dodd-Frank Act stress test rules. See 12 CFR 252.56(b). Return to text
22. See 12 CFR 252.56(b). Return to text
