The Federal Reserve is proposing to link the results of the CCAR stress tests to customized capital requirements for banks with greater than $50 billion in assets. The proposal would add an additional stress buffer requirement to ensure there is enough capital for stress losses.
Dubbed the stress capital buffer (SCB), it would be added to the PCA guidelines for an adequately capitalized bank. Here’s how it would work: If a bank has a CET1 ratio of 9 percent, but it falls to 6 percent under stress, then it would need an SCB of 3 percent. The 3 percent would be added to the PCA minimum of 4.5 percent, giving the bank a customized capital requirement of 7.5 percent.
This methodology should sound very familiar to Invictus clients.
This is almost identical to how Invictus calculates customized capital requirements for bank clients, with the remaining excess capital referred to as FreeCapital™. Invictus has been using this methodology for nearly eight years. Our clients have used the results of their stress tests to successfully negotiate a reduced capital requirement with regulators.
The Fed’s new proposal serves as a formal validation of our methodology.
It also demonstrates the folly of a one-size-fits-all approach to capital adequacy. Yet that seems to be the norm: The Senate’s proposed community bank leverage ratio, FDIC Vice Chairman Thomas M. Hoenig’s call for a 10 percent leverage ratio, etc.
Community banks that opt for such approaches are practically giving away precious capital and in turn, destroying shareholder value. They need to take matters into their own hands by calculating their own capital requirements through stress testing.
Stress testing is simply the new calculator of capital adequacy. Our foresight to utilize a stress testing methodology eight years ago is simply a reflection of our innate understanding of the big picture in today’s complicated banking world. We embraced the concept of forward-looking analytics before it was a requirement, and our clients have gained a competitive edge as a result.
Stay tuned. Our next issue of Bank Insights takes a deep look at the pitfalls of the community bank leverage ratio. Our mission is to use disruptive bank intelligence to create analytics that give our clients real value, such as freeing up regulatory capital.