The Federal Reserve Wednesday refused to rubber stamp the capital plans of five U.S. bank holding companies, objecting on the basis of either deficiencies in the capital planning practices of firms like Citigroup, or the failure of Zions Bank to meet the minimum capital requirement following the stress test.
The results of the Comprehensive Capital Analysis and Review showed that 25 large financial firms, including JP Morgan Chase and Morgan Stanley, will be allowed to distribute dividends to investors – although the Fed said banking giants Bank of America and Goldman Sachs only received the green light after submitting adjusted plans.
The central bank said that due to qualitative concerns, it objected to the capital plans of Citigroup; HSBC North America Holdings; RBS Citizens Financial Group; and Santander Holdings USA. The Fed rejected the capital plan of Zions Bancorporation “because the firm did not meet the minimum, post-stress tier-1 common ratio of 5%,” it added.
The Fed was cautiously bullish about the results, and Fed Board Governor Daniel Tarullo said in a statement that, “With each year we have seen broad improvement in the industry’s ability to assess its capital needs under stress and continuing improvements to the risk-measurement and -management practices that support good capital planning. However, both the firms and supervisors have more work to do as we continue to raise expectations for the quality of risk management in the nation’s largest banks.”
After the Fed objects to a capital plan, the financial institution may only make capital distributions with prior written approval from the Fed. A Fed official told reporters during a conference call that the firms rejected will have to resubmit their plan within 90 days or such longer period as the Fed determines appropriate.
The qualitative assessments conducted by the Fed in the CCAR are intended to take into account the different size, complexity, geographic footprint, and business models of each bank holding company. The Fed seeks to evaluate how each firm’s capital plan addresses potential risks from all its activities, the “robustness” of its capital planning process, and corporate governance and internal controls over capital planning.
The quantitative assessment requires the firm to maintain post-stress capital ratios of greater than 5% tier 1 common capital after the stress test conditions are applied.
Citigroup – one of the recipients of a government bailout during the 2008 crisis – was noted by the Fed to have made “considerable progress” in improving its general risk-management over the past several years, but its 2014 capital plan “reflected a number of deficiencies in its capital planning practices, including in some areas that had been previously identified by supervisors as requiring attention, but for which there was not sufficient improvement.”
“Taken in isolation, each of the deficiencies would not have been deemed critical enough to warrant an objection, but, when viewed together, they raise sufficient concerns regarding the overall reliability of Citigroup’s capital planning process to warrant an objection to the capital plan and require a resubmission,” the Fed said.
Bank of America and Goldman met the minimum capital requirements after submitting “adjusted capital actions.”
Looking at what the tests show about the overall state of the U.S. banking sector, the Fed said aggregate tier 1 common equity ratio, which compares high-quality capital to risk-weighted assets, of the 30 bank holding companies jumped from 5.5% in the first quarter of 2009 – when the U.S. was in recession – to 11.6% in the fourth quarter of 2013, “reflecting an increase in tier 1 common equity of more than $511 billion to $971 billion during the same period.”
Going forward, the central bank said its expects all but two of the firms that participated in this year’s CCAR – Fed would not disclose their identities – will build capital from Q2 2014 through Q1 of 2015. “In the aggregate, the firms are expected to distribute 40 percent less than their projected net income during the same period,” the Fed said.
As part of the CCAR, the Fed expects each firm to incorporate, as part of its capital-planning process, analysis of the potential for significant and rapid changes in the risks it faces, “including risks generated by a marked deterioration in the economic and financial environment as well as pressures that may stem from firm-specific events.”
The key is to ensure each will have sufficient capital to continue to operate through such environments in order to ensure “a more stable financial system that is strong enough to weather stressful events in the future,” the Fed said.