Supervisory Stress Testing of Bank Holding Companies

Dodd-Frank Act Stress Test 2013:

Supervisory Stress Test Methodology

The Federal Reserve expects large, complex bank holding companies (BHCs) to hold sufficient capital to continue lending to support real economic activity, even under adverse economic conditions. Stress testing is one tool that helps bank supervisors to measure whether a BHC has enough capital to support its operations throughout periods of stress. The Federal Reserve previously highlighted the use of stress tests as a means of assessing capital sufficiency under stress during the 2009 Supervisory Capital Assessment Program (SCAP) and the 2011 and 2012 Comprehensive Capital Analysis and Review (CCAR) exercises.

In the wake of the financial crisis, the Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which requires the Federal Reserve to conduct an annual stress test of large BHCs and all nonbank financial companies designated by the Financial Stability Oversight Council (FSOC) for Federal Reserve supervision to evaluate whether they have sufficient capital to absorb losses resulting from adverse economic conditions. The Dodd-Frank Act also requires BHCs and other financial companies supervised by the Federal Reserve to conduct their own stress tests. The Federal Reserve adopted rules implementing these requirements in October 2012. Under the rules, 18 BHCs are part of the Dodd-Frank Act supervisory stress tests this year (DFAST 2013).

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. 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. 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. 

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

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.

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 “midcycle” 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.

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.

Table 1 provides a summary of four key projected stressed capital ratios for the 18 BHCs and Table 2 provides the details for each of the 18 BHCs.

 

 

        

                                                   

Table 3 provides a summary of the projected loan losses for the 18 BHCs and

Table 4 provides the details for each of the 18 BHCs.

 

                                                            

 

 

                            


The following Macroeconomic data was utilized in

the Dodd-Frank Act Stress test 2013.              

 

BDS - Supervisory Stress Test Database