Our Take: financial services regulatory update – February 16, 2024
Change remains a constant in financial services regulation. Read "our take" on the latest developments and what they mean.
Current topics – February 16, 2024
- 1. Fed releases 2024 stress test scenarios
- 2. FinCEN proposes expanding AML requirements to investment advisers
- 3. On Our Radar
1. Fed releases 2024 stress test scenarios
- What happened: On February 15th, the Fed released the scenarios for the 2024 Comprehensive Capital Analysis and Review (CCAR), which is expected to evaluate 32 banks - including nine that participate every other year.
- What’s new relative to last year: The 2024 CCAR severely adverse scenario includes the following characteristics as compared to the scenario in the 2023 exercise:
- There is a larger decline in long-term interest rates (3.7% vs 3.25%) and equity prices (55% vs 45%)
- Consumer Price Index (CPI) inflation falls from a lower peak than in 2023 (2.8% vs 3.25%)
- There is a slightly lower decline than in 2023 in house prices (36% vs 38%) and real GDP (8.5% vs 8.75%)
- There is no change in the overall unemployment increase (6.5% to the same peak of 10.0%) or in the decline in corporate real estate (CRE) prices (40%)
- There is a slightly higher peak in BBB-rated corporate bond yield spreads (5.8% vs 5.75%)
- In addition, the Fed will conduct an “exploratory analysis” with four separate hypothetical elements, the latter two of which will only apply to the eight U.S. global systemically important banks (GSIBs):
- Funding stress resulting in rapid repricing of deposits at large banks in the context of a moderate global recession, increasing inflation, and rising interest rates
- Funding stress resulting in rapid repricing of deposits at large banks in the context of a severe global recession and high and persistent inflation and rising interest rates
- A market shock featuring sudden dislocation to financial markets, including the failure of five hedge funds with the largest counterparty exposures for each firm, due to expectations of reduced global economic activity
- A market shock featuring sudden dislocation to financial markets, with the same hedge fund failures, stemming from expectations of severe recessions in the U.S. and other countries
- What’s next: CCAR submissions are due by April 5th and results are released in June. The Fed will publish aggregate results of the exploratory analysis, which will not affect capital requirements.
Our Take
Few changes to core scenarios. With the new exploratory analyses providing an avenue for the Fed to understand the impact of more unusual circumstances outside its scenario design framework, the core CCAR scenarios feature very slight changes from last year. For the most part, this should present little to no challenge to the largest banks’ mature stress testing and capital management practices. However, even though the drop in CRE prices is the same as last year’s scenario, it is a decline from current levels which are already stressed for many portfolios. That said, it remains unlikely that any banks will fall below their risk-based minimum capital requirements or face significant changes to their stress capital buffers (SCBs), which integrate Fed-modeled start-to-trough stressed capital depletions plus four quarters of planned dividends into each bank’s capital requirements.
Exploratory analyses are here to stay. Following last year’s experiment with an exploratory market shock (EMS), the Fed wants to continue to challenge the banks and explore the integration of funding and liquidity stress with the capital stress tests in a systematic way. While it is not clear whether firms will be required to run these scenarios internally, most will likely choose to do so to understand the potential impact, particularly those that had already designed “stagflation” style scenarios similar to last year’s EMS. Although they will not yet impact capital requirements, the question remains as to how the Fed will consider the results of these analyses in the supervisory process. Banks should take a close look at their funding models, especially deposit and secured funding models, and consider how the mix between non-interest bearing and interest bearing deposits is accounted for in their forecasts.
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