As an early Christmas present, major banking and business associations filed a lawsuit on the 24th of December against the Federal Reserve System’s Board of Governors, challenging the annual stress tests that determine bank capital requirements.
The Federal Reserve showing that it had received such a wish list had pre-emptively issued a press release on the 23rd of December stating that it would “soon seek public comment on significant changes to improve transparency of bank stress tests & reduce volatility of resulting capital requirements”.
The plaintiffs, including the Bank Policy Institute, American Bankers Association, and U.S. Chamber of Commerce, argue that the stress-testing process lacks transparency and violates the Administrative Procedure Act by not allowing public input on scenarios and models. Greg Baer, president and CEO of the Bank Policy Institute said: “The current opaque regime, combined with the lack of clear standards for the global market shock and the operational risk charge, continues to produce capital charges that are inaccurate, volatile and excessive, resulting in reduced lending and economic growth.”
The lawsuit seeks to overturn the 2019 and 2020 Board actions that established the current stress-test regime and demands that the Federal Reserve subject its stress-testing frame
work to public notice and comment before implementation in 2026.
Since 2019, capital requirements for major U.S. banks have evolved significantly, influenced by the outcomes of the Federal Reserve’s annual stress tests. These tests assess banks’ abilities to withstand economic shocks, leading to adjustments in the Common Equity Tier 1 (CET1) capital ratios and stress capital buffers.
Bank of America (BAC) saw its CET1 requirement at 9.5% in 2020, with a stress capital buffer of 2.5%. By 2024, the CET1 requirement decreased to 8.5%, while maintaining the same buffer.
Citigroup (C) started with a 10% CET1 requirement and a 2.5% stress capital buffer in 2020. These figures increased to 12.1% and 4.1% respectively by 2024.
Goldman Sachs (GS) had one of the highest initial requirements, with a CET1 of 13.6% and a 6.6% buffer in 2020. By 2024, the CET1 requirement rose slightly to 13.7%, while the buffer decreased to 6.2%.
JPMorgan Chase (JPM) faced a CET1 requirement of 11.3% in 2020, with a 3.3% buffer. By 2024, these figures adjusted to a CET1 of 12.3% and a 3.3% buffer.
Morgan Stanley (MS) started with a CET1 requirement of 13.4% and a 6.4% buffer in 2020. By 2024, the CET1 requirement rose to 13.7%, while the buffer decreased to 6.2%.
Overall, the evolution of CET1 and stress capital buffers across these banks shows a variable trend of increasing capital requirements, driven by stress test outcomes each year.
The lawsuit reflects the growing tension between regulatory oversight and industry concerns about transparency and predictability in capital requirement determinations. Banking groups argue that the current process creates unpredictable and potentially unjustified capital burdens that could affect lending capacity and economic growth.
The banking sector’s capital requirements face potential contradictory institutional developments with on the one hand potential policy shifts under the new US administration and the implementation of Basel III. The outcome of these developments will significantly influence the future of bank capital requirements and the broader financial system’s regulatory framework.
©Markets Media Europe 2024
