Tarullo Says Fed to Assess Banks’ Capital Planning Year-Round

Federal Reserve Governor Daniel Tarullo said the central bank is turning its annual stress test and capital review program into a cornerstone of year-round supervision of banks, some of which still lack effective risk management and strong board oversight.

A Fed Board committee responsible for the annual capital review “will directly engage with firms during the course of the year to evaluate progress in remediating weaknesses or other issues identified” in the test, Tarullo said in the text of remarks delivered at a Fed conference in Boston.

“Some firms still lack reliable information about their businesses and exposures,” Tarullo said.

The Fed has used the annual stress test as a tool to assure capital adequacy at the biggest banks and to hold management teams to tougher risk management and liquidity standards. Tarullo, the governor in charge of bank supervision, said the tests will constantly evolve as new risks and innovations appear in the financial system. He was also cited a “continuing need for improvement” in banks’ capital planning processes.

“Firms also are sometimes unable to measure or understand how stressful conditions can change the performance of their material business lines,” he said.

Banks need a better grasp of how to assess the impact of unusual and improbable risks, he said, adding that “these deficiencies are, in some instances, compounded by weak oversight by senior management and boards of directors, and lack of effective checks and accountability in the process.”

Financial Crisis

Stress testing was developed in 2009 as then Fed Chairman Ben S. Bernanke looked for ways to restore confidence in a banking system that had just weathered the worst financial crisis and recession since the Great Depression.

The initial test involved 19 banks, which held two-thirds of the assets and more than half of the loans in the U.S. banking system.

The Fed approved the capital plans of 25 of the 30 banks tested in March. Citigroup Inc., as well as units of Royal Bank of Scotland Group Plc, HSBC Holdings Plc and Banco Santander SA failed because of the quality of their stress test processes, the Fed said in a statement.

Zions Bancorporation failed after its capital fell below Fed minimums in a simulation of a severe economic slump.

The KBW Bank Index, which tracks 24 U.S. banks, including Capital One Financial Corp., JPMorgan Chase & Co., and M&T Bank Corp., is up 2.7 percent this year compared with a 5.5 percent gain for the Standard & Poor’s 500 Index.

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