Capital & Valuations
Escalating regulatory attention on risk calculations, stress testing, capital planning, and broad risk management鈥攁cross financial risks as well as operational risks
Calculation
The federal banking regulators (FRB, FDIC, OCC) will jointly seek to increase the strength and聽 resilience of the banking system through changes to the large bank capital requirements (all Category I to IV banking organizations with assets of $100+ billion), including applying a broader set of capital聽 requirements to more large banks and standardizing certain aspects of the capital framework. The聽 effect of the changes, which would implement the final components of the international capital standards (e.g., the Basel III agreement) in the US as well as markedly change the U.S. 鈥渢ailoring rules鈥澛� (e.g., impose more requirements on all Category II, III, and IV banking organizations), is expected to聽 vary for each bank based on its activities and risk profile.
The regulators intend for changes to introduce more transparency, consistency, and risk sensitivity to聽 the measurement of risk-weighted assets. Firms should anticipate regulatory focus across core risk聽 areas (e.g., operational risk, credit risk, market risk) as well as business lines and corporate functions.
- Risk-Weightings: Adjustments to risk-weighted capital calculations include:
- Operational Risk: Standardized approach would use a function of firms鈥� 鈥渂usiness indicator聽 components鈥� and 鈥渋nternal loss multipliers鈥�.
- Credit Risk: Expanded risk-based approach with increased 鈥渞isk sensitivity鈥� from additional criteria聽 and metrics for differentiation of credit risk within exposure categories and a broader range of risk聽 weights for various asset classes (e.g., exposures to depository institutions, foreign banks, and聽 credit unions; subordinated debt; real estate, retail, and corporate exposures).
- Market Risk: Standardized and internal model approaches for calculating risk-weighted assets for聽 market risk; introduces the concept of a trading desk and restricts application of the models-based聽 approach to the trading desk level.
- Credit Valuation Adjustment Risk: New, standardized approach allows recognizing hedges for聽 expected exposure component of CVA risk.
- Securitization Exposures and Equity Exposures.
- Whole of Business: For all impacted institutions, changes to capital requirements will drive聽 extensive changes in governance processes, data, models, system infrastructure, internal controls,聽 and regulatory reporting, which will span both business lines and corporate functions over a聽 multiyear timeframe. Further, firms (regardless of size) should anticipate that regulators may request聽 information on practices and data that seem to be a 鈥渢ier up鈥� from current category levels.
Framework
Changes to the capital requirements will also impact:
- Stress Testing: Revised calculations under the proposed 鈥渄ual-requirement capital聽 structure with output floors鈥� (i.e., a requirement that risk-based capital ratios be聽 calculated under both the 鈥渆xpanded risk-based approach鈥� and the 鈥渟tandardized聽 approach鈥� and the lower of the two be used for each risk-based capital ratio) will drive聽 (re)assessment and (re)alignment of existing stress testing frameworks with the need聽 for additional scenarios, including scenarios that consider the impact of rising rates on聽 asset values, deposit stability, liquidity, and earnings.
- Capital Planning and Balance Sheet Management: Capital planning and balance聽 sheet management strategies will evolve based on the new approaches/requirements;聽 expect heightened data requirements, supervisory scrutiny of models, and more聽 granular reporting.
- Accounting and tax: Changing capital plans, balance sheet management strategies,聽 and corresponding adjustments will potentially result in changes to accounting and tax聽 calculations (e.g., AOCI, DTA).
Risk management
In combination with economic uncertainties and interest rate pressures, changes to the capital requirements will focus supervisory attention to:
- Impacts and Metrics: Evaluation of the impact changed capital requirements would have on聽 portfolios and products, as well as reassessment of risk management metrics and thresholds to聽 align with evolving capital requirements.
- Unrealized Losses: Impact of potential new requirements to recognize unrealized losses on聽 available-for-sale securities in regulatory capital and related changes to capital and liquidity risk聽 management programs (see 04 Growth & Resiliency).
- Credit Vulnerabilities: Increasing risks (e.g., repricing, default) amidst rising interest rates,聽 tightening of credit terms (e.g., loan size, maturities, collateralization, interest rate floors), and聽 weaknesses in select sectors (e.g., urban commercial real estate鈥攐ffices, hotels); regulators聽 will look to stress testing and scenario analysis as ways to identify and measure the impact of聽 credit vulnerabilities (e.g., concentrations, highly leveraged borrowers, lower-rated borrowers).
- Long-Term Debt: For large banks and BHCs (e.g., $100+ billion), plans to issue and maintain聽 minimum levels of eligible long-term debt sufficient to absorb losses or to provide capital in a聽 resolution (i.e., as required through an interagency rulemaking).
What to Watch
Regulatory attention, based on the proposed capital requirements, will focus on the impacts and implications to firms鈥� business processes, capital and risk calculations, and capital planning and investment strategies.
- Capital Requirements: Proposed 鈥淏asel III Endgame鈥�: Interagency (FRB, FDIC,聽 OCC) proposal to substantially change regulatory capital requirements impacting聽 large banks with $100+ billion in total assets; the changes would implement final聽 components of the Basel III agreement in the US as well as make changes to the US聽 鈥渢ailoring 谤耻濒别蝉.鈥�
- Long-Term Debt Requirements: Interagency (FRB, FDIC, OCC) proposal to impose long-term debt requirements for certain large banks and holding companies with聽 assets of $100+ billion.
Call to Action鈥�
- Conduct current-state assessment: Evaluate the existing governance, data, data聽 quality, models, system infrastructure, internal controls, regulatory reporting, and capital聽 strategies to identify areas where remediation is needed considering the new capital聽 requirements. Assess changes to regulatory reporting and build needed capabilities to聽 include process, system, and technology changes. Start collecting data and perform pro聽 forma RWA impact analyses on banks鈥� portfolios. Identify potential data gaps to support聽 the proposed rules.
- Establish centralized coordination: Implement a coordinated approach to drive the聽 various transition efforts across business lines and corporate functions, streamlining the聽 process and ensuring compliance with the proposed rules.
- Optimize business and investment strategies: Banks should reconsider their strategies聽 to comply with the new capital requirements鈥攑articularly in light of the impacts to聽 various components including credit and operational risks (especially for larger, complex聽 institutions)鈥攑aying particular attention to risk-sensitive areas such as high-leverage/聽 private equity exposures, resecuritization, and large trading activities.
- Prepare implementation and compliance timeline: Develop a comprehensive聽 multiyear, firmwide plan to achieve compliance with the proposed rules, considering聽 the transition period and the proposed compliance dates. Understand capacity planning聽 to execute changes, specifically for data, analytics and modeling teams, which will be聽 constrained as credit conditions continue to be volatile into 2024.
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Amy S. Matsuo
Principal, U.S. Regulatory Insights & Compliance Transformation Lead, 乐鱼（Leyu）体育官网 LLP
Adam Levy
Principal, Modeling & Valuation, 乐鱼（Leyu）体育官网 LLP
Jeffrey Dykstra
Principal, Advisory, Financial Services Solutions, 乐鱼（Leyu）体育官网 US
Amy S. Matsuo
Principal, U.S. Regulatory Insights & Compliance Transformation Lead, 乐鱼（Leyu）体育官网 LLP
Adam Levy
Principal, Modeling & Valuation, 乐鱼（Leyu）体育官网 LLP
Jeffrey Dykstra
Principal, Advisory, Financial Services Solutions, 乐鱼（Leyu）体育官网 US