Other Federal Reserve Operations

Regulatory Developments: Dodd-Frank Act Implementation

Throughout 2014, the Federal Reserve continued to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) (Pub. L. No. 111-203), which gives the Federal Reserve important responsibilities to issue rules and supervise financial companies to enhance financial stability and preserve the safety and soundness of the banking system. The Board also continued to implement other regulatory reforms to increase the resiliency of banking organizations and help to ensure that they are operating in a safe and sound manner.

The following is a summary of the key regulatory initiatives that were completed during 2014.

Enhanced Prudential Standards for U.S. and Foreign Banking Organizations

Section 165 of the Dodd-Frank Act requires the Board to establish enhanced prudential standards for bank holding companies (BHCs) and foreign banking organizations with total consolidated assets of $50 billion or more and nonbank financial companies that have been designated by the Financial Stability Oversight Council (FSOC) for supervision by the Board. The standards must include enhanced risk-based and leverage capital; liquidity, risk-management, and risk-committee requirements; a requirement to submit a resolution plan; single-counterparty credit limits; stress tests requirements; and, for companies that the FSOC has determined pose a grave threat to financial stability, a debt-to-equity limit. Section 165 also permits the Board to establish additional prudential standards, including three enumerated standards--a contingent capital requirement, enhanced public disclosures, and short-term debt limits--and other prudential standards that the Board determines are appropriate.

In February 2014, the Board adopted a final rule to implement enhanced prudential standards under the Dodd-Frank Act for BHCs and foreign banking organizations with $50 billion or more in total consolidated assets. For a BHC with total consolidated assets of $50 billion or more, the final rule adopts enhanced risk-management and liquidity requirements. The 165 final rule also incorporates the Board's capital, capital planning, and stress testing requirements as enhanced prudential standards.

For a foreign banking organization with total consolidated assets of $50 billion or more, the final rule implements enhanced risk-based and leverage capital, liquidity, risk-management, and stress testing requirements. In addition, the final rule requires foreign banking organizations with U.S. non-branch assets of $50 billion or more to form a U.S. intermediate holding company and imposes enhanced prudential standards on that intermediate holding company. Generally, as the size, complexity, and risk to U.S. financial stability of a U.S. BHC or foreign banking organization increases, the standards imposed on the organization become more stringent, mitigating risks to the financial stability of the United States posed by the material financial distress or failure of the institution.

Finally, the final rule also establishes a risk-committee requirement for publicly traded U.S. and foreign banking organizations with total consolidated assets of $10 billion or more, implements stress testing requirements for foreign banking organizations and foreign savings and loan holding companies with total consolidated assets of more than $10 billion, and requires companies that the FSOC has determined pose a grave threat to the financial stability of the United States achieve and maintain a debt-to-equity ratio of no more than 15 to 1.

Continued Implementation of the Regulatory Capital Framework

In July 2013, the Board issued a final rule to comprehensively revise the capital regulations applicable to banking organizations (revised capital framework).¹ The revised capital framework strengthens the definition of regulatory capital, generally increases the minimum risk-based capital requirements, modifies the methodologies for calculating risk-weighted assets, and imposes a minimum generally applicable leverage ratio of 4 percent (measured as the ratio of tier 1 capital to on-balance-sheet assets). In addition, internationally active banking organizations must meet a minimum supplementary leverage ratio of 3 percent (measured as the ratio of tier 1 capital to on- and off-balance-sheet exposures). The rule was published jointly with the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) published a substantively identical rule.

The Board continued to develop and enhance the regulatory capital framework in 2014. In April 2014, the Board, the FDIC, and the OCC adopted a final rule that enhances the supplementary leverage ratio requirement described above for the largest, most interconnected U.S. banking organizations. A BHC with at least $700 billion in total consolidated assets or at least $10 trillion in assets under custody must maintain a supplementary leverage ratio of 5 percent or more in order to avoid limitations on distributions and certain discretionary bonus payments, and their insured depository institution subsidiaries must maintain a supplementary leverage ratio of 6 percent or more to be "well capitalized." These enhanced supplementary leverage ratio standards are designed to help reduce the probability of failure of systemically important banking organizations, thereby mitigating the risks to the financial stability of the United States posed by these organizations.

In 2014, the agencies issued three other final rules to adjust aspects of the regulatory capital framework. In July 2015, the agencies adopted a final rule to correct the definition of "eligible guarantee." In September 2014, the agencies adopted a final rule to revise the definition of total leverage exposure used in the calculation of the supplementary leverage ratio. Specifically, the final rule modifies the methodology for including off-balance-sheet items, such as credit derivatives, repo-style transactions, and lines of credit, in the denominator of the supplementary leverage ratio to more appropriately capture a banking organization's on- and off-balance-sheet exposures. In December 2014, the Board and the OCC adopted an interim final rule to adjust the definition of "qualifying master netting agreement" and related definitions in the regulatory capital and the liquidity coverage ratio rules. The changes were intended to ensure that the regulatory capital and liquidity treatment of certain financial transactions is not affected by the implementation of special resolution regimes in foreign jurisdictions or by contractual provisions that incorporate stays of special resolution regimes.

Capital Planning and Stress Testing Requirements

On an annual basis, the Federal Reserve assesses whether BHCs with total consolidated assets of $50 billion or more have effective capital planning processes and sufficient capital to absorb losses during stressful conditions, while meeting obligations to creditors and counterparties and continuing to serve as credit intermediaries. This annual assessment includes two related programs: the Comprehensive Capital Analysis and Review (CCAR), which evaluates a BHC's capital adequacy, capital adequacy process, and planned capital distributions in accordance with the Board's capital plan rule, and the Dodd-Frank Act supervisory stress tests. Pursuant to the Dodd-Frank Act, BHCs and state member banks with more than $10 billion in total consolidated assets are required to conduct company-run stress tests.

On October 16, 2014, the Board revised its capital plan and stress testing rules to adjust the time frame for annual submissions of capital plans and the company-run and supervisory stress tests. Beginning in 2016, participating BHCs must submit their capital plans and stress testing results to the Federal Reserve on or before April 5.

Liquidity Requirements for Large Financial Institutions

In October 2014, the Board, the OCC, and the FDIC issued a final rule implementing the liquidity coverage ratio (LCR), a quantitative liquidity requirement for large and internationally active banking organizations. The LCR is the first broadly applicable quantitative liquidity requirement for U.S. banking firms and establishes an enhanced prudential liquidity standard consistent with the Dodd-Frank Act. Under the final rule, covered banking firms will be required to maintain a minimum amount of high-quality liquid assets sufficient to cover their net cash outflows over a 30-calendar-day period in a standardized supervisory stress scenario. The most stringent LCR requirements apply to banking organizations with consolidated total assets of $250 billion or more or consolidated total on-balance-sheet foreign exposure of $10 billion or more and their subsidiary insured depository institutions with $10 billion or more of consolidated total assets. The rule applies a simpler, less stringent LCR requirement to certain smaller depository institution holding companies with $50 billion or more that are not otherwise covered by the rule.

Credit-Risk Retention

In December 2014, the Board--jointly with other federal banking agencies, the Department of Housing and Urban Development, the Federal Housing Finance Agency, and the Securities and Exchange Commission (SEC)--approved a final rule to implement the credit-risk retention requirements in the Dodd-Frank Act. The final rule generally requires the sponsors of securitization transactions to retain not less than 5 percent of the credit risk of the assets they securitize and includes prohibitions on transferring or hedging the retained credit risk. The final rule provides exemptions for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as qualified residential mortgages (QRMs). In addition, the final rule does not require risk retention for securitizations of commercial loans, commercial mortgages, or automobile loans, provided that the transactions meet specific standards for high-quality underwriting. The implementing agencies have agreed to review the QRM definition and its effect on the residential mortgage market no later than four years after the rule's effective date and periodically thereafter.

The Volcker Rule: Prohibitions against Proprietary Trading and Other Activities

Section 619 of the Dodd-Frank Act generally prohibits insured depository institutions (IDIs) and their affiliates (collectively, banking entities) from engaging in proprietary trading or from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund. These prohibitions and other provisions of section 619 are commonly known as the "Volcker rule."

In January 2014, the Board, the FDIC, the OCC, the SEC, and the Commodity Futures Trading Commission approved an interim final rule permitting banking entities to retain interests in, and act as sponsors to, certain collateralized debt obligations backed primarily by trust preferred securities that meet the definition of covered funds, as permitted under the grandfathering provisions for certain trust preferred securities in the Dodd-Frank Act. The interim final rule, a companion rule to the Volcker rule approved in December 2013, establishes specific qualifications for the type of covered funds that may be retained.

Financial Sector Concentration Limits

In November 2014, the Board issued a final rule to implement section 622 of the Dodd-Frank Act, which generally prohibits a financial company from merging or consolidating with, or from acquiring, another company if the resulting company's liabilities would exceed 10 percent of the aggregate liabilities of all financial companies. Financial companies subject to the limit include insured depository institutions, BHCs, savings and loan holding companies, foreign banking organizations, companies that control insured depository institutions, and nonbank financial companies designated by the FSOC for Board supervision. In addition, the final rule establishes reporting requirements for financial companies that do not otherwise report consolidated financial information to the Board or another federal banking agency, in accordance with the Bank Holding Company Act.

Risk-Management Standards for Financial Market Utilities

Title VIII of the Dodd-Frank Act establishes a supervisory framework for financial market utilities (FMUs) that are designated as systemically important by the FSOC. FMUs are multilateral systems that provide the essential infrastructure for transferring, clearing, and settling payments, securities, and other financial transactions among financial institutions or between financial institutions and the system.

In October 2014, the Board approved final amendments to Regulation HH regarding the risk-management standards for FMUs that have been designated as systemically important by the FSOC and for which the Board has standard-setting authority under the Dodd-Frank Act. The Board also approved revisions to the Federal Reserve Policy on Payment System Risk, which applies to financial market infrastructures more generally, including those operated by the Federal Reserve Banks.² The final rule adopts standards to address credit risk and liquidity risk, new requirements on recovery and orderly wind-down planning, a new standard on general business risk, a new standard on tiered participation arrangements, and heightened requirements on transparency and disclosure.

Key Regulatory Initiatives Proposed in 2014

A number of important regulatory developments are in the proposal stage. The following is a summary of additional regulatory initiatives that the Board proposed in 2014.

Capital Surcharge for Global Systemically Important Banking Organizations

In December 2014, the Board invited comment on a proposed rule that would establish a methodology to identify whether a U.S. BHC is a global systemically important banking organization (GSIB). As such, a GSIB would be subject to a risk-based capital surcharge that is calibrated based on its systemic risk profile. The proposal builds on a GSIB capital surcharge framework designed by the Basel Committee on Banking Supervision and augments that framework to address the risk arising from reliance on short-term wholesale funding. Failure to maintain the capital surcharge would subject the GSIB to restrictions on capital distributions and certain discretionary bonus payments.

Enhanced Prudential Standards for the Regulation and Supervision of General Electric Capital Corporation

In December 2014, the Board invited public comment on enhanced prudential standards for the regulation and supervision of General Electric Capital Corporation (GECC), a nonbank financial company that the FSOC designated for supervision by the Board. In light of the substantial similarity of GECC's activities and risk profile to that of a similarly sized BHC, the proposal would apply enhanced prudential standards to GECC that are generally similar to those that apply to large BHCs, including standards for risk-based and leverage capital, capital planning, stress testing, liquidity, and risk management.

Clarifications to Regulatory Capital Rules

The Board continues to implement the regulatory capital rules. In December 2014, the federal banking agencies issued a proposed rule to make technical corrections and clarify certain aspects of the advanced approaches rule. Also in December 2014, the Board issued a proposed rule to provide additional information regarding the application of the Board's regulatory capital framework to depository institution holding companies that have nontraditional capital structures.

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The Board of Governors and the Government Performance and Results Act

Overview

The Government Performance and Results Act (GPRA) of 1993 requires federal agencies, in consultation with Congress and outside stakeholders, to prepare a strategic plan covering a multiyear period. GPRA also requires each agency to submit an annual performance plan and an annual performance report. The GPRA Modernization Act of 2010 further refines those requirements to include quarterly performance reporting. Although the Board is not covered by GPRA, the Board follows the spirit of the act and, like other federal agencies, prepares an annual performance plan and an annual performance report.

Strategic Framework, Performance Plan, and Performance Report

The Board's 2012-15 Strategic Framework (framework) articulates the Board's mission within the context of resources required to meet Dodd-Frank Act mandates, close cross-disciplinary knowledge gaps, develop appropriate policy, and continue addressing the recovery of a fragile global economy. The framework sets forth major goals, outlines strategies for achieving those goals, and identifies key measures of performance toward achieving the strategic objectives.

The annual performance plan outlines the planned projects, initiatives, and activities that support the framework's long-term objectives and resources necessary to achieve those objectives. The annual performance report summarizes the Board's accomplishments that contributed toward achieving the strategic goals and objectives identified in the framework.

The framework, performance plan, and performance report are available on the Board's website at www.federalreserve.gov/publications/gpra/files/2012-2015-strategic-framework.pdf, www.federalreserve.gov/publications/gpra/files/2014-gpra-performance-plan.pdf, and www.federalreserve.gov/publications/gpra/files/2013-gpra-performance-report.pdf.

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References

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