The Securities Industry and Financial Markets Association (SIFMA) along with the International Swaps and Derivatives Association (ISDA) offered feedback to the Federal Reserve Board of Governors on its revised capital plan rule and stress capital buffer (SCB) requirement.
In a letter to the Fed Board, SIFMA and ISDA commended the Fed for addressing the longstanding and unwarranted volatility of the SCB, mainly by averaging the results over a two-year period. However, they said the revised proposal fails to address more fundamental drivers of SCB volatility. These drivers include the implausibility of the supervisory stress scenarios and the overlap with the risk-based capital framework.
“These core issues lead to SCBs that are not only excessively volatile but also not reflective of underlying risks,” SIFMA and ISDA wrote in the letter to the Fed. “The combination of excessive volatility and miscalibration relative to underlying risks constrains large banking organizations’ capacity to intermediate the U.S. capital markets and support economic growth. As such, broader and more material reforms that address these fundamental issues are required to ensure the supervisory stress testing framework remains relevant and effective.”
The two organizations also offered five recommendations to improve the proposal. The recommendations state:
- A banking organization should be permitted, for the 2025 stress testing cycle, to have its SCB requirements determined under the current SCB rule through September 30, 2026, regardless of whether the proposal is finalized with an effective date on or prior to October 1, 2026.
- An asymmetric averaging approach should be adopted to determine the SCB requirement. Asymmetric averaging of two-year supervisory stress test results would enable SCB requirements to adapt quickly to reduced risks and allow large banking organizations time to manage increased risks, resulting in efficient capital allocation.
- The dividend add-on component should be removed from supervisory stress tests. The dividend add-on component is conceptually inconsistent with the maximum payout ratio requirement under the capital rules and should be removed from supervisory stress tests.
- The supervisory stress testing framework includes assumptions that are not consistent with post-crisis reforms or market practice. The current supervisory stress testing framework, which dates to early 2009, does not account for the risk-mitigating benefits of these post-crisis financial reforms and strengthened risk management practices.
- The supervisory stress testing framework is conceptually inconsistent with the RWA framework. The current U.S. capital rules stipulate that large banking organizations must calculate certain RWAs to reflect stressed market conditions. The Board should reform both the supervisory stress testing framework and the RWA framework to ensure their conceptual consistency.
“We are strongly committed to maintaining the safety and efficiency of U.S. financial markets and hope the Agencies implement our recommendations, which reflect the extensive knowledge and experience of market professionals within the Associations and our members,” SIFMA and ISDA concluded in their letter. “Our recommendations are designed to make the U.S. capital framework more risk sensitive to avoid the potential adverse consequences of the Proposal on financial markets, consumers, end-users and the economy more generally.”