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Board of Governors of the Federal Reserve System
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Comprehensive Capital Analysis and Review 2015:
Assessment Framework and Results, March 2015

Capital Plan Assessment Framework and Factors

The Federal Reserve conducted a full review of the capital plans submitted by the 31 BHCs, including both a qualitative assessment of the strength of each BHC's internal capital planning processes and a quantitative assessment of each BHC's capital adequacy, each as described below.


Qualitative Assessment

The CCAR 2015 qualitative assessment covered all key areas of BHCs' capital planning processes and involved a large number of experts from across the Federal Reserve System, in addition to the supervisory teams from each Federal Reserve District with a BHC in CCAR.9 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 worked and consulted with the primary federal banking agencies for the BHCs' subsidiary insured depository institutions--the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.

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 firmwide activities.10 The Federal Reserve also evaluates the reasonableness of a BHC's capital plan, the assumptions and analysis underlying the plan, and the strength of the firm's capital planning processes. 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 captures the specific risks and vulnerabilities faced by the firm under stress. (See box 3 for more on the Federal Reserve's expectations for foundational risk identification.) As in years past, the Federal Reserve gave particular attention to the processes surrounding 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.

The Federal Reserve has differing expectations for capital planning for BHCs depending upon their size, scope of operations, activities, and systemic importance. In particular, the Federal Reserve has significantly heightened expectations for those BHCs that are subject to the Federal Reserve's LISCC program. The Federal Reserve expects the LISCC firms, which because of their size and complexity pose elevated risk to the U.S. financial system and economy, to have the most sophisticated, comprehensive, and robust risk-management and capital planning practices to help ensure their resiliency to a range of unexpected stress events.

The financial crisis exposed a number of important weaknesses in these 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 may object to a BHC's capital plan based on the qualitative assessment of the practices supporting the BHC's capital planning on any of the following grounds:

  • There are material unresolved supervisory issues, including but not limited to issues associated with the BHC's capital adequacy process;
  • 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 adequacy 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.11

The comparative evaluation of 31 BHCs simultaneously allows the Federal Reserve to gain an understanding of the relative strengths and weaknesses across the industry. However, 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 a 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 deficiencies. BHCs that receive an objection generally have a critical deficiency in one or more material areas, have significant deficiencies in a number of areas that undermine the overall reliability of the BHC's capital planning process, or have significant deficiencies that were identified in previous reviews for which the firm has not made adequate progress in remediating.

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Box 3. Material Risk Identification and Capital Planning

In CCAR 2015, a particular area of supervisory focus was whether a BHC had a comprehensive process for identifying the full range of relevant risks arising from its exposures and business mix, including those exposures that may become apparent only under stress. Material risk identification requires governance processes and risk-measurement and risk-assessment practices that enable a BHC to maintain a current and comprehensive view of the key risks to which it is exposed. An effective risk-identification process is fundamental to a strong capital adequacy process, as it allows a BHC to understand the range of material risks to which it is exposed, including how those risks may affect the BHC in a stressful scenario, and to assess its capital needs commensurate with those risks.

The specifics of the material risk-identification process will differ across BHCs given differences in organizational structure, business activities, and size and complexity of operations. However, an effective process should cover all material risks pertaining to both on- and off-balance sheet exposures, and significant business lines and operational activities, including risks that may only emerge during stressful conditions. The process should be dynamic to reflect changes in the BHC's exposures and business activities and changes in macroeconomic and other external factors. It should incorporate input from multiple stakeholders across the organization and comprehensively capture and evaluate risks across the entire BHC.

The material risk-identification process should inform all key aspects of a BHC's enterprise-wide stress testing and capital planning. For example, in developing the BHC stress scenario, each BHC should explicitly consider how macroeconomic and financial market conditions or firm-specific events would affect its material risks and ensure that its stress scenarios capture key factors that affect those risks effectively. The BHC's senior management and board of directors should also consider material risks in assessing the adequacy of post-stress capital levels and the appropriateness of potential capital actions, including both issuance or distributions, in light of the BHC's capital needs.

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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 a 5 percent tier 1 common capital ratio and above the applicable minimum regulatory capital ratios in effect during each quarter of the planning horizon.12 The CCAR quantitative assessment is based on the results of the BHCs' internal stress tests under supervisory scenarios and the BHCs' own scenarios and post-stress capital ratios estimated by the Federal Reserve under the supervisory scenarios (CCAR supervisory post-stress capital analysis).

The CCAR supervisory post-stress capital analysis is based on the estimates of losses, revenues, balances, risk-weighted assets, and capital from the Federal Reserve's supervisory stress test conducted under the Dodd-Frank Act.13 (For a comparison of the Dodd-Frank Act stress tests and CCAR, see box 4). As described in the overview of the methodology of the Dodd-Frank Act supervisory stress tests published on March 5, 2015, for these projections, the Federal Reserve uses data provided by the 31 BHCs and a set of models developed or selected by the Federal Reserve.14

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.15 While the same supervisory scenarios applied to all BHCs, a subset of BHCs were subject to additional components in the severely adverse and adverse scenarios--the global market shock and counterparty default scenario components.16 BHCs were also required to conduct stress tests using the same supervisory stress scenarios, at least one stress scenario developed by the BHC (BHC stress scenario), and a BHC baseline scenario.

As noted above, CCAR post-stress capital analysis incorporates a BHC's planned capital actions included in the BHC's capital plan under its baseline scenario to project post-stress capital ratios. Thus, the BHCs are assumed to maintain the level of dividends and share repurchases they 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 health even if the economy deteriorated and the BHC continued to make its planned capital distributions--as many companies continued to do well into the financial crisis.

The Federal Reserve provided each BHC with an 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 planned common stock dividends and/or reducing planned repurchases or redemptions of other regulatory capital instruments, relative to those initially submitted by the BHCs in their January 2015 capital plans. These adjusted capital actions, where applicable, were then incorporated into the Federal Reserve's projections to calculate adjusted post-stress capital levels and ratios. For any BHC that submitted adjusted capital actions, the Federal Reserve is disclosing the post-stress results incorporating the original capital actions in addition to the results using the adjusted capital actions.

Box 4. 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 Dodd-Frank Act supervisory stress tests and the CCAR quantitative assessment incorporate the same projections of losses, revenues, balances, 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.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. Repurchases of such capital instruments are assumed to be zero. The capital action assumptions do not include issuance of new common stock, preferred stock, or other instruments that would be included in regulatory capital, except for common stock issuance associated with expensed employee compensation, or in connection with a planned merger or acquisition.

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 and a tier 1 common capital ratio of 5 percent even if stressful conditions emerged and the BHC did not reduce its planned capital distributions.

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 the net issuance of common equity or any other instrument that counts toward regulatory capital, 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.

1. To make the results of its supervisory stress tests comparable to the company-run stress tests, the Federal Reserve generally 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

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References

9. For further information about supervisory expectations for a BHC's capital adequacy process, see Board of Governors of the Federal Reserve System (2013), Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice(Washington: Board of Governors, August), www.federalreserve.gov/bankinforeg/bcreg20130819a1.pdfReturn to text

10. 12 CFR 225.8(f)(1). Return to text

11. See 12 CFR 225.8(f)(2)(ii). Return to text

12. In CCAR 2015, the tier 1 common ratio is calculated under the definition of capital and risk-weighted assets in 12 CFR part 225, appendixes A and E. See 12 CFR 225.8(d)(13). The minimum regulatory capital ratios include three risk-based capital ratios--common equity tier 1 capital ratio, tier 1 capital ratio, and total capital ratio--and the tier 1 leverage capital ratio. See 12 CFR part 217. Return to text

13. For more on the methodology of the Federal Reserve's supervisory stress test, see Board of Governors of the Federal Reserve Board (2015), "Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results" (Washington: Board of Governors, March 5), http://federalreserve.gov/newsevents/press/bcreg/bcreg20150305a1.pdfReturn to text

14. For CCAR 2015, 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 Board of Governors of the Federal Reserve Board (2015), "Appendix B: Models to Project Net Income and Stressed Capital," p. 51, footnote 33, in "Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results," (Washington: Board of Governors, March 5), http://federalreserve.gov/newsevents/press/bcreg/bcreg20150305a1.pdfReturn to text

15. The stress tests each BHC conducts using the supervisory scenarios also fulfill the requirements of 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, subpart F. Return to text

16. 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 System (2014), "2015 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule" (Washington: Board of Governors, October 23), www.federalreserve.gov/newsevents/press/bcreg/bcreg20141023a1.pdfReturn to text

Last update: March 18, 2015

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