Alert August 27, 2013

FRB Issues Paper on Capital Planning at Large Bank Holding Companies

The FRB issued a paper (the “Paper”) entitled “Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice.”  The FRB’s capital planning rule requires all U.S.-domiciled, top-tier bank holding companies with $50 billion or more of total consolidated assets (“Covered BHCs”) to have a capital plan “supported by a robust process for assessing their capital adequacy.”

There were 18 Covered BHCs tested by the FRB in its 2013 cycle, and there will be 30 Covered BHCs reviewed by the FRB in its 2014 testing cycle (which the FRB said will begin in the Fall of 2013).  The FRB stated that Covered BHCs “have considerably improved their capital planning processes in recent years, but have more work to do to enhance their practices for assessing the capital they need to withstand stressful economic and financial conditions,….”  Among the weaknesses cited by the FRB in some Covered BHCs’ capital planning processes were an inability to show how all risks were accounted for during the capital planning process, using stress-test scenarios and modeling techniques that failed to address distinct vulnerabilities of the Covered BHC’s business model, unrealistic loss projections and failure to articulate clearly the Covered BHC’s strategy for maintaining a capital buffer during a time of financial stress.

The Paper describes the FRB’s supervisory expectations for the capital planning of Covered BHCs in light of the seven principles of effective capital adequacy process listed below:

  • Sound foundational risk management
  • Effective loss-estimation methodologies
  • Solid resource-estimation methodologies
  • Sufficient capital adequacy impact assessment
  • Comprehensive capital policy and capital planning
  • Robust internal controls
  • Effective governance

In the Paper, the FRB describes what it regards as leading capital planning practices, but warns that adoption of the identified leading practices does not offer a “safe harbor” to a Covered BHC.  In addition, the FRB emphasized that a Covered BHC should have “a systematic and repeatable process to identify all risks and consider the potential impact to capital from those risks.”  In the Paper the FRB also discusses the important roles to be played by a Covered BHC’s Board and Senior Management in ensuring that a standardized and effective capital planning process is established and regularly updated.

Although the FRB’s Paper applies only to Covered BHCs and the FRB has heightened supervisory expectations for the largest and most complex BHCs, it is clear that the FRB expects that BHCs that are not large enough to be Covered BHCs should nonetheless have in place capital planning processes that reflect their smaller size and lower level of complexity.