Fed to set bank capital levels via pre-pandemic stress test model: Quarles By Reuters

Fed to set bank capital levels via pre-pandemic stress test

© Reuters. Federal Reserve Vice Chairman for Supervision Randal Quarles addresses the Economic Club of New York in New York


By Pete Schroeder

WASHINGTON (Reuters) – The U.S. Federal Reserve will continue to rely on a stress test built before the onset of the coronavirus pandemic to set big bank capital requirements but will make use of pandemic-specific analysis to inform whether banks can pay out funds to investors, a top official said Friday.

Fed Vice Chair Randal Quarles said in a speech that the Fed is testing banks against three possible economic trajectories of varying severity to see how they perform, citing “unprecedented uncertainty” about the pandemic’s long-term economic impact. Those results will help the Fed decide whether banks can pay out extra funds to investors via dividends or share repurchases.

Quarles’s remarks Friday mark the first details the Fed has provided on its ramped-up stress tests, which the central bank said it was augmenting in April with pandemic-related “sensitivity analyses.”

The extra portions of the test will see how banks perform against three “plausible” economic outcomes: a rapid “V-shaped” recovery, a slower “U-shaped” recovery, and a tumultuous “W-shaped” recovery. The latter two are expected to be more severe than the original Fed stress test, according to Quarles.

However, the Fed is not going to use those results to dictate how much banks must hold as a capital cushion. Rather, Quarles said the original test scenario will continue to provide the basis for each bank’s capital levels. Instead, the Fed will consider the extra analysis in evaluating bank plans to distribute excess capital, including through dividends and share repurchases.

“The sensitivity analysis will help the () Board assess whether additional measures are advisable for certain banks or certain future developments,” said Quarles, according to prepared remarks.

Quarles said banks will be able to draw up capital plans after receiving their test results, and the Fed will announce each firm’s final capital requirements later this year before they take effect in the fourth quarter.

While banks grumbled about the late change to this year’s test, Quarles acknowledged that the Fed’s original scenario published in February had been overtaken by the actual economic downturn in several ways, forcing adjustments.

“We simply would not have been doing our jobs if we had just run the test using a scenario framed before the economy began to deteriorate in March,” he said, according to prepared remarks.

The Fed is due to publish the 2020 test results on June 25. Quarles said the Fed will provide firm-specific data on its original test as in prior years, but only provide aggregate data on how banks performed in the additional pandemic analysis.

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