3 minute read 15 Jul 2020
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Capital management: Navigating through economic uncertainty

Authors
Adam Girling

Principal, Financial Services, Ernst & Young LLP

Advises US and global banks on enhancing business performance. Helps them improve financial planning, resource optimization, and risk management capabilities.

Marc Saidenberg

EY Financial Services Global Regulatory Network Co-Lead, Principal US Financial Services Consulting, Ernst & Young LLP

Financial services advisor. Facilitating active dialogue between industry and the public sector. Public speaker and thought leader. Husband and father.

3 minute read 15 Jul 2020

The Fed released this year’s Dodd-Frank Act Stress Test (DFAST) and Comprehensive Capital Analysis and Review (CCAR) results on June 25, 2020.

Thirty-three firms, each with greater than $100 billion in total consolidated assets, were subject to supervisory stress tests this year. This includes the Category IV firms under the Fed’s tailoring rule that are subject to supervisory stress tests every other year.

All participating firms are subject to the new Stress Capital Buffer (SCB) requirement, finalized in March 2020. Per the capital and stress test rules, the SCB requirements and firm-specific disclosures will be released by 8/31, based on the Supervisory Severely Adverse results (pre-COVID Scenario), and incorporating firms’ planned dividends.

In light of the economic deterioration and uncertainty caused by the COVID-19 pandemic, the Fed conducted additional sensitivity analysis based on alternative economic recovery paths (V, U, W). The Fed will use the results of the sensitivity analysis to inform its views of the appropriateness of capital distributions and ongoing supervision of firms.

Overall highlights

  • Firms face a cap on capital distributions through the third quarter of 2020, at a minimum, and will be required to resubmit capital plans within 45 days of receiving revised Fed scenarios later this year, in response to ongoing uncertainty surrounding the recovery
  • Firms exhibit a range of practice with regards to their ability to adequately plan and forecast capital in a rapidly changing economic environment, with many firms relying more heavily on qualitative approaches due to limitations in their models
  • No firms breached the regulatory minimums under the Supervisory Severely Adverse Scenario under DFAST
  • Aggregate CET1 ratio depletion from actuals to stress trough is 210 bps, which does not include common dividend distributions, unlike prior years
  • Given CET1 ratio minimums and assuming dividends consistent with prior year, implied SCB levels by bank category range from 310 bps for Large and Complex to 420 bps for Large and Complex Foreign Banking Organizations (FBOs)¹; while ranges look similar across categories, individual firms range from 250 bps to 779 bps
  • Several large FBOs that were subject to a potential qualitative objection did not receive an objection to their capital plans
  • Sensitivity Analysis showed aggregate declines in CET1 ratios of 250 bps, 390 bps, 430 bps under the V-, U-, and W-shaped recovery paths, respectively, at stress trough, with peak unemployment reaching between 15.6% and 19.5% across the three recovery paths
  • The Fed did not disclose nor did it provide to firms the firm-specific results under the sensitivity analysis, but did emphasize that some firms would fall below minimum capital requirements under the W-shaped recovery path
  • There is a wide dispersion in the mean CET1 results under the sensitivity analysis, with several firms potentially facing basis point impacts well in excess of the aggregate industry losses
  • Show article references

    ¹ Based on a weighted average by four bank categories: G-SIB, Large & Complex FBO, Large and Complex Other, Large and Non-complex.

Summary

Looking ahead, firms must ensure they have the proper tools and capabilities in place to effectively navigate through the ongoing economic uncertainty. Capital management must continue to evaluate alternative scenarios in allocation and risk management decisions, and in assessing distributions relative to both the SCB and the possibility of further Fed actions.

About this article

Authors
Adam Girling

Principal, Financial Services, Ernst & Young LLP

Advises US and global banks on enhancing business performance. Helps them improve financial planning, resource optimization, and risk management capabilities.

Marc Saidenberg

EY Financial Services Global Regulatory Network Co-Lead, Principal US Financial Services Consulting, Ernst & Young LLP

Financial services advisor. Facilitating active dialogue between industry and the public sector. Public speaker and thought leader. Husband and father.