Fixing the roof while the sun – wait, is that rain?
The Fed is split on whether to apply a countercyclical buffer. But so is everyone else
The Fed is split on whether to apply a countercyclical buffer. But so is everyone else
Grade inflation is the tendency to award progressively higher scores for test results of equal merit. The result (typically according to critics who graduated some years earlier) is a steady deterioration in academic standards at schools and colleges, rather than the reported improvement.
It’s also a charge levelled at the Federal Reserve in the context of the Comprehensive Capital Analysis and Review (CCAR), the central bank’s gold-standard stress test for large lenders. To pass, banks have to hurdle a minimum Common Equity Tier 1 capital ratio threshold of 4.5% under stress and a leverage ratio of 4%.
The class of 2019, made up of 18 banks, breezed the tests, reporting a median stressed CET1 ratio of 9.6%. The same participants last year posted a median ratio of 7.9%.
What’s strange about this is that the CCAR is supposed to get tougher as the US economy improves; countercyclicality is built into the Fed’s stress scenario-designing policy. So, is the regulator easing off on its charges like an indulgent professor? And what does this mean for banks’ resilience?
The industry’s response to the first question is a resounding ‘no’. The Bank Policy Institute, a trade body, says banks have improved their CCAR performances because they have shed assets that turned to junk during the global financial crisis, the event upon which the Fed’s stress scenarios are based. To extend the grade inflation metaphor, the tests haven’t been dumbed down, the students have genuinely gotten smarter.
If this is true, then higher post-stress CET1 ratios show banks are tougher now than in years past and better able to withstand a crisis. But this in turn invites another question: from this position of strength, should banks be pushed to set aside additional capital for a rainy day?
The Fed could achieve this by activating the countercyclical capital buffer (CCyB), a tool introduced by the Basel Committee on Banking Supervision that forces banks to stockpile reserves during good times so they can be used to support lending when things turn sour.
Switching on the CCyB is a hot topic at the US regulator. Boston Fed president Eric Rosengren has said the benign US economy means it’s an “ideal time” to switch on the capital buffers. But on the flipside, governor Randal Quarles, a member of the Fed’s board, supports a 0% buffer. The board as a whole affirmed a 0% setting in March.
On the other side of the Atlantic, 13 EU member states have implemented or announced a non-zero buffer, but the consensus is skin-deep: actual buffer levels range from 2.5% in Sweden, to 1% in the UK and 0.25% in France.
These disagreements within and between countries illustrate an uncomfortable truth about the buffer. There is no science in its application, yet – some nations will switch it on too early, and some will switch it on too late.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Our take
Quants are using language models to map what causes what
GPT-4 does a surprisingly good job of separating causation from correlation
China stock sell-off will test securities firms’ risk managers
Regulatory measures to support stock market could add to risks facing securities sector
Why some UK pensions might choose to run on
Buyouts are booming but trustees are thinking about alternatives, too
Choppy inflation may be the worst inflation
Investors can build strategies to suit fast-rising prices, or slow-rising prices. What trips them up is the inflation foxtrot: slow, slow, quick, quick, slow
A dynamic margin model takes shape
New paper shows how creditworthiness and concentrations can be reflected into margin requirements
Why ‘Derivatives’ became ‘Markets’
The derivatives markets have changed drastically over the past decade. So has Risk.net’s coverage
Uncertain rates outlook poses challenge for corporate FX hedgers
Hedging programmes may need a revamp as EM/G10 rates differentials narrow
Europe’s half-baked benchmark switch leaves some dissatisfied
Users frustrated by narrow scope of euro transition, but replacing Euribor was never a euro group objective
Most read
- Quants are using language models to map what causes what
- Reluctantly, CME moves to clear US Treasuries
- The bank quant who wants to stop gen AI hallucinating