Tag: Federal Reserve

Fed’s final stress capital buffer is credit negative for US banks

On 4 March, the Federal Reserve Board (Fed) finalized changes to its capital rules for US banks with assets greater than $100 billion. Via Moody’s.

The final changes increase the flexibility banks have to payout capital more aggressively and will likely give bank management greater leeway to reduce the size of their management buffers and operate with capital ratios closer to the minimum levels required.

The final version establishes a stress capital buffer (SCB) that incorporates the Fed’s stress test results into its regulatory Pillar 1 capital requirements for these banks. Originally proposed in April 2018, the final rule includes a number of changes that weaken the original, making it credit negative for all US banks covered by the rule.

The Fed’s impact analysis of the final rule suggests that in aggregate the Common Equity Tier 1 (CET1) capital requirements at the affected US banks could decline up to $59 billion: $6 billion at the eight US global systemically important banks (G-SIBs) and $35 billion at the rest. Since most banks currently hold a management buffer above existing requirements, the affected banks could actually cut their CET1 capital by twice this amount and still comply with the final rule. The CET1 capital reduction could be $40 billion (a 5% decline) at the G-SIBs, $50 billion (a 21% decline) at other banks with $250 billion or more in assets, and $35 billion (a 16% decline) at
banks with assets between $100 and $250 billion.

Consistent with the proposal, the final rule integrates stress testing into the Fed’s regulatory capital requirements by replacing the capital conservation buffer, which is currently 2.5%, with the SCB. The SCB will be the higher of either 2.5%, or the difference between the starting and minimum projected CET1 capital ratio under the severely adverse scenario of the Fed’s Dodd-Frank Act Stress Test (DFAST) plus four quarters of planned common stock dividends.

Starting in October 2020, if a bank’s risk-based capital ratios fall below the aggregate of the minimum capital requirement plus the SCB, the relevant G-SIB surcharge, and the countercyclical capital buffer (if any), restrictions would apply to capital payouts and certain discretionary bonus payments.
As in the proposal, the final rule changes the current annual Comprehensive Capital Analysis and Review (CCAR) and DFAST process.

The final rule eliminates the assumption that a bank’s balance sheet and risk-weighted assets will grow under the stress scenarios, eliminates the Fed ability to object on quantitative grounds to a bank’s capital plan, and removes the 30% dividend payout ratio as a threshold for heightened scrutiny of a bank’s capital plan. Both the flat balance sheet assumption and the requirement that banks hold capital for only four quarters of dividends rather than for the full amount of planned payouts over the stress test horizon lower capital requirements versus the current stress testing regime.

The decrease is only partially offset for G-SIBs by the first-time inclusion of the G-SIB surcharge within the Fed’s stress test.

The final rule is weaker than the original proposal for several reasons. Under the proposal, banks would not have been allowed to pay out capital in excess of their approved capital plans without Fed prior approval. In the final rule, banks can in most cases make payouts in excess of amounts in their capital plan, provided the payout is otherwise consistent with the payout limitations in the final rule.

Additionally, the final rule modifies payout limitations to allow firms with an SCB in excess of 2.5% to pay a greater portion of their dividends and management bonuses and to repurchase shares for a period of time after capital ratios fall below the requirement. And in the final rule, the SCB, unlike the DFAST capital requirements, will not incorporate material business plan changes, such as those resulting from a merger or acquisition. As a result, such actions will only affect a bank’s capital ratio once the action has occurred.

The final rule also excludes the originally proposed stress leverage buffer requirement, which would not have been a binding constraint for most banks. Its elimination from the final rule removes this requirement as a potential backstop. And without the stress leverage buffer, the still pending proposal to modify the supplementary leverage ratio for the eight G-SIBs by tying it more closely to the G-SIB surcharge could further weaken the ability of the leverage ratio to serve as a backstop requirement and would also be credit negative.

Federal Reserve Board Approves Simplified Capital Rules for Large Banks

The US Federal Reserve Board on Wednesday approved a rule to simplify its capital rules for large banks, preserving the strong capital requirements already in place.

The “stress capital buffer,” or SCB, integrates the Board’s stress test results with its non-stress capital requirements. As a result, required capital levels for each firm would more closely match its risk profile and likely losses as measured via the Board’s stress tests. The rule is broadly similar to the proposal from April 2018, with a few changes in response to comments.

“The stress capital buffer materially simplifies the post-crisis capital framework for banks, while maintaining the strong capital requirements that are the hallmark of the framework,” Vice Chair for Supervision Randal K. Quarles said.

The SCB uses the results from the Board’s supervisory stress tests, which are one component of the annual Comprehensive Capital Analysis and Review (CCAR), to help determine each firm’s capital requirements for the coming year. By combining the Board’s stress tests—which project the capital needs of each firm under adverse economic conditions—with the Board’s non-stress capital requirements, large banks will now be subject to a single, forward-looking, and risk-sensitive capital framework. The simplification would result in banks needing to meet eight capital requirements, instead of the current 13.

The SCB framework preserves the strong capital requirements established after the financial crisis. In particular, the changes would increase capital requirements for the largest and most complex banks and decrease requirements for less complex banks. Based on stress test data from 2013 to 2019, common equity tier 1 capital requirements would increase by $11 billion in aggregate, a 1 percent increase from current capital requirements. A firm’s SCB will vary in size throughout the economic cycle depending on several factors, including the firm’s risks.

To reduce the incentive for firms to take on risk and further simplify the framework, the final rule does not include a stress leverage buffer as proposed. All banks would continue to be subject to ongoing, non-stress leverage requirements.

Large banks have substantially increased their capital since the first round of stress tests in 2009. The common equity capital ratio of the banks in the 2019 CCAR has more than doubled from 4.9 percent in the first quarter of 2009 to 12.2 percent in the fourth quarter of 2019, with total capital doubling to more than $1 trillion.

Also on Wednesday, the Board released the instructions for the 2020 CCAR cycle. The instructions confirm that 34 banks will participate in this year’s test. CCAR consists of both the stress tests that assess firms’ capital needs under stress and, for the largest and most complex banks, a qualitative evaluation of the practices these firms use to determine their capital needs in normal times and under stress. Results will be released by June 30.

Rate Cuts Don’t Cure Viruses

As expected the RBA cut the cash rate to 0.5% “the Board took this decision to support the economy as it responds to the global coronavirus outbreak”.

RBA Cuts, As Expected

All the major banks passed on the cut in full (thanks to severe political pressure), though gritted teeth. The profit pressure at the banks just went up a notch, on our modelling, a potential fall of more than 3%, though for some regionals perhaps double that. Players like Suncorp also passed on the cut.

The Government has said there will be a targetted package to assist businesses soon, and before the May budget. The savings deeming rate is now completely out of wack with even the very best deposit rates available, so pensioners, those on Government support and welfare are being hit by the gap. The deeming rate for singles is currently 3.0% for assets over $51,200 and 1.0% for those under that threshold. One way the Government is “balancing” the budget

Overnight the FED cut, in an expected “unexpected” drop of 50 basis points. This was the first time the Fed had cut by more than 25 basis points since 2008 and the reduction marks a stark shift for Powell and his colleagues. They had previously projected no change in rates during 2020, remaining on the sidelines during the election year, after lowering their benchmark three times in 2019. They of course rejected any political influence despite Trump’s consistent pressure to drop rates.

Its become very clear that central bankers are worried not only about the economic impact of COVID-19 but also the losses in the stock market.

The Fed said the coronavirus outbreak had disrupted economies in many countries and these measures will weigh on activity for some time. The magnitude and persistence of the impact is uncertain but the risks to their outlook changed enough to justify a move to support the economy. He added that there will be more action by each G7 nation along with the possibility of formal coordination. In other words, more easing is on the way from other central banks including the Fed if the sell-off in stocks deepens and the global slowdown worsens. This was aimed to restore confidence in the market, it did not.

The OECD indicated that economic growth could fall to as low as 1.5% for this year. The Fed’s decision could trigger a wave of easing from other central banks around the world although those in the euro-area and Japan have less scope to follow with rates already in negative territory.

The G7’s issued a statement that was to the point:

We, G7 Finance Ministers and Central Bank Governors, are closely monitoring the spread of the coronavirus disease 2019 (COVID-19) and its impact on markets and economic conditions.

Given the potential impacts of COVID-19 on global growth, we reaffirm our commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.  Alongside strengthening efforts to expand health services, G7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase.  G7 central banks will continue to fulfill their mandates, thus supporting price stability and economic growth while maintaining the resilience of the financial system.

We welcome that the International Monetary Fund, the World Bank, and other international financial institutions stand ready to help member countries address the human tragedy and economic challenge posed by COVID-19 through the use of their available instruments to the fullest extent possible.

But the point is, no rate cut, or government stimulus can cure the virus, which continues to spread with person to person transmission on the rise.

The latest WHO update says eight new Member States (Andorra, Jordan, Latvia, Morocco, Portugal, Saudi Arabia, Senegal, and Tunisia) reported cases of COVID-19 in the past 24 hours. Globally 90,870 cases have been confirmed (1,922 new), with China 80,304 confirmed (130 new) and 2,946 deaths (31 new). Outside of China 10,566 cases are confirmed (1,792 new) in 72 countries (8 new) with 166 deaths (38 new).

The flow on effects in terms of reduced commerce is significant, with more businesses unable to source raw materials or distribute good. Across transport and tourism, and education the impacts are immediate, but other sectors are following. Hence the expectation of slowing growth.

The question becomes, at what point do businesses cease to trade, or pay their employees, and to what extent will households also hunker down (many were already).

The US markets reacted badly to the FED’s move, with the Dow down close to 3%.

The ASX was also down in early trading.

The supply side consequences of the virus, could well flow on the credit markets, and in this case lower interest rates – other than as a confidence signal will not help.

Central bank tools are not going to cure the virus, and lower rates and more QE liquidity might well make the situation worse. Fiscal responses can provide a little more support, perhaps, though Governments seem reluctant to play that card hard.

We are in uncharted territory, and I do not think Central Banks can save us this time.

Statement from Federal Reserve

Jerome Powell just issued this “don’t panic” message.

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.

The calls from the markets for central bank intervention and fiscal stimulus are rising fast. However, this could well be finger in the dyke stuff….

Yield Curve Inverts, Briefly

The fears relating to the coronavirus and weakish consumer sentiment from the US, plus the Feds hold decision turned the tables on the US yield curve overnight, with the 3-month rate 2 basis points higher than the 10-year at one point. Its slightly positive now… but this is a sign of uncertainty.

Plus a measure of core U.S. inflation released on Thursday showed price pressures slowed to an annualized 1.3% in the fourth quarter from 2.1%, a weaker figure than analysts had expected. And below the Fed’s target.

The dip will be seen as some as a warning signal because it has inverted before each of the past seven U.S. recessions. The last inversion was at the height of the trade war.

But it also is driven by the thought that the Fed may need to pump more liquidity into the market, despite the assurance they were planning to ease back their open market operations in the next few months. This means buying more treasuries out along the curve. – Price up means yields fall.

Clearly, investors are looking for some form of safety and buying Treasuries out the curve is really the only way to do it.

And Bloomberg says that falling yields also triggered other market dynamics which are exacerbating the move. Convexity hedging — when mortgage portfolio managers buy or sell bonds to manage their duration exposure — is back in play. As yields fall, they make purchases.

The sequence of a swift drop in yields and curve flattening unleashing convexity-linked forces that re-starts the cycle is a recurring feature of the Treasury market .

A massive wave of convexity-related hedging in the swaps market in March helped send 10-year yields to levels then not seen since 2017. That came after the Fed took an abrupt shift away from policy tightening they had been doing in 2018. The Fed went on to cut rates three times over all of 2019.

Other factors may be at work now as well. Structural demand for long-dated Treasuries — linked to liability-driven investment and hedging from foreign investors including Taiwanese insurers — has helped to drive the curve flatter, according to Citigroup Inc.

We think its too soon to know whether this is an over-reaction, but once again it underscores markets are on a hair trigger. So expect more volatility ahead.

Fed Holds Cash Rate (As Expected)

The Fed kept the cash rate on hold, and there was little change to the commentary, other than a slightly weaker set of words surrounding the consumer.

Growth in household spending moderated toward the end of last year, but with a healthy job market, rising incomes, and upbeat consumer confidence, the fundamentals supporting household spending are solid. In contrast, business investment and exports remain weak, and manufacturing output has declined over the past year. Sluggish growth abroad and trade developments have been weighing on activity in these sectors. However, some of the uncertainties around trade have diminished recently, and there are some signs that global growth may be stabilizing after declining since mid-2018. Nonetheless, uncertainties about the outlook remain, including those posed by the new coronavirus. Overall, with monetary and financial conditions supportive, we expect moderate economic growth to continue.

Information received since the Federal Open Market Committee met in December indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although household spending has been rising at a moderate pace, business fixed investment and exports remain weak. On a 12‑month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee decided to maintain the target range for the federal funds rate at 1‑1/2 to 1-3/4 percent. The Committee judges that the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation returning to the Committee’s symmetric 2 percent objective. The Committee will continue to monitor the implications of incoming information for the economic outlook, including global developments and muted inflation pressures, as it assesses the appropriate path of the target range for the federal funds rate.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.

Fed Says Some SME Online Lender Websites Are Flawed

The US Federal Reserve Board on Thursday released Uncertain Terms: What Small Business Borrowers Find When Browsing Online Lender Websites, a report that examines the information that prospective small business borrowers encounter when researching and comparing credit products offered by online lenders.

Nonbank online lenders are becoming more mainstream alternative providers of financing to small businesses. In 2018, nearly one-third of small business owners seeking credit reported having applied at a nonbank online lender. The industry’s growing reach has the potential to expand access to credit for small firms, but also raises concerns about how product costs and features are disclosed. The report’s analysis of a sampling of online content finds significant variation in the amount of upfront information provided, especially on costs. On some sites, descriptions feature little or no information about the actual products or about rates, fees, and repayment terms. Lenders that offer term loans are likely to show costs as an annual rate, while others convey costs using terminology that may be unfamiliar to prospective borrowers. Details on interest rates, if shown, are most often found in footnotes, fine print, or frequently asked questions.

The report’s findings build on prior work, including two rounds of focus groups with small business owners who reported challenges with the lack of standardization in product descriptions and with understanding product terms and costs.

In addition, the report finds that a number of websites require prospective borrowers to furnish information about themselves and their businesses in order to obtain details about product costs and terms. Lenders’ policies permit any data provided by the small business owner to be used by the lender and other third parties to contact business owners, often leading to bothersome sales calls. Moreover, online lenders make frequent use of trackers to monitor visitors on their websites. Even when visitors do not share identifying information with the lender, embedded trackers may collect data on how they navigate the website as well as other sites visited.

US Agencies Find “Shortcomings” For Several Large Financial Firms

The Federal Reserve Board and Federal Deposit Insurance Corporation announced Tuesday that they did not find any “deficiencies,” which are weaknesses that could result in additional prudential requirements if not corrected, in the resolution plans of the largest and most complex domestic banks. However, plans from six of the eight banks had “shortcomings,” which are weaknesses that raise questions about the feasibility of a firm’s plan, but are not as severe as a deficiency. Plans to address the shortcomings are due to the agencies by March 31, 2020.

Resolution plans, commonly known as living wills, describe a bank’s strategy for rapid and orderly resolution under bankruptcy in the event of material financial distress or failure.

In the plans of Bank of America, Bank of New York Mellon, Citigroup, Morgan Stanley, State Street, and Wells Fargo, the agencies found shortcomings related to the ability of the firms to reliably produce, in stressed conditions, data needed to execute their resolution strategy. Examples include measures of capital and liquidity at relevant subsidiaries. The agencies did not find shortcomings in the plans from Goldman Sachs and J.P. Morgan Chase.

The firms will receive feedback letters, which will be publicly available on the Board’s website. For the six firms whose plans have shortcomings, the letter details the specific weaknesses and the actions required. Overall, the letters note that each firm made significant progress in enhancing its resolvability and developing resolution-related capabilities but all firms will need to continue to make progress in certain areas.

To that end, the letters confirm the agencies expect to focus on testing the resolution capabilities of the firms when reviewing their next plans. Resolving a large bank would be challenging and unprecedented, and the agencies expect the firms to remain vigilant as markets change and as firms’ activities, structures, and risk profiles change.

The agencies also announced on Tuesday that Bank of America, Goldman Sachs, Morgan Stanley, and Wells Fargo had successfully addressed prior shortcomings identified by the agencies in their December 2017 resolution plan review.

Kitchen Sink From The Fed – Up To $365 Billion In The Next Month! [Podcast]

The latest from the Federal Reserve, and the trade talks – are they connected? Why the lift in repo transactions ahead?

https://www.newyorkfed.org/markets/opolicy/operating_policy_191212

Digital Finance Analytics (DFA) Blog
Digital Finance Analytics (DFA) Blog
Kitchen Sink From The Fed – Up To $365 Billion In The Next Month! [Podcast]
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