Dodd-Frank Act Stress Test 2013: Supervisory Stress Test
Methodology and Results
- Federal Reserve Supervisory Stress Test Framework and Model Methodology
- Federal Reserve Supervisory Stress Test Results
- Appendix A: Severely Adverse Scenario
Dodd-Frank Act Stress Testing
The Dodd-Frank Act requires the Federal Reserve to conduct an annual supervisory stress test of BHCs with $50 billion or more in total consolidated assets and nonbank financial companies designated by the FSOC for Federal Reserve supervision (collectively, "covered companies"). The Dodd-Frank Act also requires covered companies to conduct their own stress tests (company-run stress tests) semiannually.7 Together, the Dodd-Frank Act supervisory stress tests and the company-run stress tests are intended to provide BHC management and boards of directors, the public, and supervisors with forward-looking information to help identify downside risks and the potential effect of adverse conditions on capital adequacy of these large banking organizations. The Federal Reserve adopted rules implementing these requirements in October 2012.
Under the implementation phase-in provisions of the Federal Reserve's Dodd-Frank stress test rules, only the 18 BHCs that previously participated in the SCAP are required to conduct company-run stress tests during the current stress test cycle that began in October 2012.8 Similarly, the Federal Reserve has conducted supervisory stress tests on only these 18 BHCs for DFAST 2013. Both sets of stress tests are also integrated into the Federal Reserve's assessment of capital adequacy under CCAR. Important differences between the Dodd-Frank Act supervisory stress tests and the CCAR post-stress capital analysis are outlined in box 1.
To provide context to the Federal Reserve's Dodd-Frank Act supervisory stress test results, the following sections contain an overview of the Federal Reserve's Dodd-Frank Act stress test rules, focusing on the process for the supervisory stress tests and the requirements for company-run stress tests for covered companies.
Supervisory Stress Tests
In this Section:
Under the Dodd-Frank Act stress test rules, the Federal Reserve conducts annual supervisory stress tests to evaluate whether a covered company has the capital, on a total consolidated basis, necessary to absorb losses and continue its operations by maintaining ready access to funding, meeting its obligations to creditors and other counterparties, and continuing to serve as a credit intermediary under adverse economic and financial conditions. As part of this supervisory stress test for each covered company, the Federal Reserve projects revenue, expenses, losses, and resulting post-stress capital levels, regulatory capital ratios, and the tier 1 common ratio under three scenarios (baseline, adverse, and severely adverse), using data as of September 30.
The Federal Reserve generally uses a common set of scenarios for all covered companies in the supervisory stress test. However, the Federal Reserve may use additional scenarios or components of scenarios for all or a subset of the covered companies to capture salient sources of risk, and these scenarios may use data from dates other than the end of the third quarter. In DFAST 2013, large, complex BHCs with significant trading activities are subject to a global market shock that reflects general market stress and heightened uncertainty, which affects trading positions and elevates counterparty credit risk.
The Dodd-Frank Act codified the Federal Reserve's practice of disclosing a summary of the results of its supervisory stress test. In this paper, the Federal Reserve is disclosing the results of the 2013 Dodd-Frank Act supervisory stress tests conducted under the severely adverse scenario, including firm-specific results based on the projections made by the Federal Reserve of each BHC's revenues, expenses, losses, and post-stress capital ratios over the planning horizon.9
Box 1. 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 post-stress capital analysis. The projections of pre-tax net income from the Dodd-Frank Act supervisory stress tests are direct inputs to the CCAR post-stress capital analysis. The primary difference between the Dodd-Frank Act supervisory stress tests and the CCAR post-stress capital analysis 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.1 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. The assumptions are that repurchases of common stock are zero. The capital action assumptions do not include issuance of new common stock, preferred stock, or other instrument that would be included in regulatory capital, except for common stock issuance associated with expensed employee compensation.2
Capital Actions for CCAR
In contrast, for the CCAR post-stress capital analysis, the Federal Reserve uses BHCs' planned capital actions, and assesses whether a BHC would be capable of meeting supervisory expectations for minimum capital ratios even if stressful conditions emerged and the BHC did not reduce planned capital distributions.
As a result, post-stress capital ratios projected for the Dodd-Frank Act supervisory stress tests should be expected to differ significantly from those for the CCAR post-stress capital analysis. For example, if a BHC includes a dividend cut 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. Conversely, if a BHC includes significant dividend increases, repurchases, or other actions that deplete capital in its planned capital actions, the post-stress capital ratios for the CCAR could be lower.
1. In order 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, outlined in the Dodd-Frank stress test rules. See 12 CFR 252.146(b)(2). Return to text
2. The Dodd-Frank Act stress test rule for covered companies assumes that future capital actions that are subject to future adjustment, market conditions, or other regulatory approvals will not be reflected in a company's projected regulatory capital for the purpose of the company-run stress tests because of the uncertainty of these actions. Accordingly, under the rule, a company must assume in the second through ninth quarters of the planning horizon no redemption or repurchase of any capital instrument eligible for inclusion in the numerator of a regulatory capital ratio. See 12 CFR 252.146(b)(2)(iii). The Federal Reserve clarified in subsequent guidance that, for similar reasons, a company should assume that it will not issue any new common stock, preferred stock, or other instrument that would be included in regulatory capital in the second through ninth quarters of the planning horizon, except for common stock issuances associated with expensed employee compensation. Return to text
Company-Run Stress Tests
As required by the Dodd-Frank Act, the Federal Reserve's stress test rules require covered companies to conduct two company-run stress tests each year. In conducting the "annual" test, a covered company uses data as of September 30 and reports its stress test results to the Federal Reserve by January 5. In addition, a covered company must conduct a "mid-cycle" test and report the results to the Federal Reserve by July 5. The Dodd-Frank Act stress test rules align the timing of annual company-run stress tests with the annual supervisory stress tests of covered companies.
In their annual stress tests, covered companies subject to the Dodd-Frank Act stress test rules must use the scenarios provided by the Federal Reserve. Each year, the Federal Reserve will provide at least three scenarios--baseline, adverse, and severely adverse--that are identical to the scenarios the Federal Reserve uses in the annual supervisory stress tests of covered companies.10 By providing a common set of scenarios to all firms, the results of company-run and supervisory stress tests for all 18 BHCs will be based on comparable underlying assumptions. To further enhance comparability, the supervisory stress tests and company-run stress tests conducted under the Dodd-Frank stress test rules use the same set of capital action assumptions. According to these assumptions, over the nine-quarter planning horizon, each BHC maintains its common stock dividend payments 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; but repurchases of such capital instruments and issuance of stock is assumed to be zero.
Finally, each covered company must publicly disclose a summary of the results of its company-run stress test under the severely adverse scenario provided by the Federal Reserve.
7. The Dodd-Frank Act requires all financial companies that have more than $10 billion in total consolidated assets and are regulated by a Federal financial regulatory agency to conduct capital stress tests at least annually. The Federal Reserve finalized those requirements for BHCs with between $10 billion and $50 billion in assets and state member banks and savings and loan holding companies with over $10 billion in assets on October 9, 2012. See 12 CFR part 225, subpart H. Return to text
8. Six state member bank subsidiaries of BHCs that participated in SCAP are also required to conduct stress tests this year under the Federal Reserve's "Annual Company-Run Stress Test Requirements for Banking Organizations with Total Consolidated Assets over $10 Billion Other Than Covered Companies" (12 CFR part 252, subpart H). Those banks are Bank of New York Mellon; Fifth Third Bank; Goldman Sachs Bank USA; Regions Bank; State Street Bank and Trust Company; and SunTrust Bank. Return to text
9. For DFAST 2013, similar to the public disclosure following CCAR in early 2012, the Federal Reserve is only disclosing results under the severely adverse scenario for each company. As the Federal Reserve implements the Dodd-Frank Act stress testing requirements, it intends to evaluate whether public disclosure of the results of the adverse and baseline would assist in informing the company and market participants about the condition of the banking organization. Return to text
10. Under the stress test rules, the Federal Reserve will provide the scenarios to companies no later than November 15 each year. See 12 CFR 252.144(b)(1); 12 CFR 252.154(b)(1). Return to text