The Federal Reserve may require large banks to increase their capital reserves or cut their dividend payments and share buybacks if they continually fail to accurately assess their own potential risks and financing needs, The Wall Street Journal reported Aug. 19.
The Fed has been increasingly vigilant about tying a bank’s strong capital plans to its ability to provide investors with dividends and share buybacks.
The Fed’s August 2013 report “Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice” noted that most banks have made sufficient progress in preparing for another major economic downturn, but noted that there still is significant room for improvement when it comes to passing stress tests.
Each of the 18 banks that submitted capital plans to the Fed showed flaws, including unrealistic loss projections, failure to show how they account for risk in making capital decisions and failure to explain how they would maintain capital buffers in times of economic stress. The Fed’s report said many banks were overly optimistic about losses in the event of another financial crisis.
Financial institutions have complained that the Fed’s annual stress tests have pressured them to meet ever higher capital levels that have adversely affected their ability to make loans to businesses and to consumers. They also claimed that the Fed’s evaluation of their capital plans has been inconsistent.
According to the Journal, the Fed has proposed additional requirements for the nation’s largest banks, including an increase in leverage ratio, which is the amount of capital that banks hold against their total assets. Banks also may be required to hold minimum amounts of long-term debt and banks that rely on short-term funding may be required to hold greater capital.