Tuesday, November 06,
2018 / 11:42
AM / Fitch Ratings
Recently proposed changes to how regulatory capital and liquidity is managed and reported at US large regional banks continues the bifurcation of regulatory relief between Global Systemically Important Banks (GSIBs) and smaller peers, says Fitch Ratings.
Generally, the proposed relaxation of regulatory and capital standards is a negative for creditors at US large regional banks, especially the potential loss of the comparability of annual public stress tests. Still, we do not anticipate ratings changes directly as a result of the proposed changes, with the ultimate ratings impact dependent on how banks respond to, and operate under, more relaxed regulatory requirements.
We expect banks to most likely proceed with caution in decommissioning stress testing and related elements, such as resolution planning, especially given the potential for changes in the political and regulatory environment in the future. We expect highly-rated banks to continue to exercise disciplined capital and liquidity risk management.
The proposal responds to the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, which altered asset size thresholds under which US regulators, including the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation, imposed enhanced prudential standards. The proposal would tailor regulatory standards and divide banks with more than $100 billion in assets, or $75 billion in foreign activity, into one of four categories. Key considerations include not only asset size but also include the amount of wholesale short-term funding, non-bank assets, off-balance-sheet exposure and the level of international activities.
Category IV banks, with assets between $100 billion-$250 billion ,not exceeding any of the four risk thresholds would see the most meaningful reduction of capital and liquidity requirements. These banks would no longer be subject to the liquidity coverage ratio (LCR) and proposed net stable funding ratio (NSFR) liquidity requirements and would no longer need to conduct stress tests. Instead, banks in this category would only be required to run supervisory stress tests every two years.
Category III banks, with assets of $250 billion or more, or banks that trip a $75 billion risk threshold, also have lower proposed requirements. Banks in this category with less than $75 billion in short-term wholesale funding may be subject to only a 70%-85% of full LCR and NSFR requirements, a credit negative in Fitch's view.
Also, stress tests would be conducted and reported only every two years instead of semi-annually. Notably, should the proposal pass, these banks will be able to exclude adjusted other comprehensive income (AOCI), which captures changes in securities values, from regulatory capital. This could inflate capital ratios, despite not increasing loss capacity due to a reversal of unrealized loss positions.
Under the proposal Category II banks, which at present would include only Northern Trust (AA-/Stable), with significant size of $700 billion, or greater in assets, or $75 billion or more in cross-jurisdictional activity, will not face surcharges or total loss-absorbing capacity/long-term debt requirements as GSIBs currently do. However, Category II banks will not be able to opt out of AOCI capital inclusion, will still face advanced risk-based capital approaches, and will see no relief in liquidity requirements.
Category I banks, US GSIBs, as expected would see minimal regulatory relief and would still be subject to the most stringent capital and liquidity standards, a credit positive in our view. However, stress tests would be run annually instead of semi-annually.
All US large regional banks incurred substantial sunk costs for stress-test/regulatory compliance since the financial crisis. While costly and time consuming, banks are rewarded with more robust information and improved data analytics. We expect these investments to facilitate implementation for upcoming Current Expected Credit Loss Standard compliance and other potential regulations and also with ongoing financial planning and analysis.