Capital & Valuations
Escalating regulatory attention on risk calculations, stress testing, capital planning, and broad risk management—across financial risks as well as operational risks
Calculation
The federal banking regulators (FRB, FDIC, OCC) will jointly seek to increase the strength and resilience of the banking system through changes to the large bank capital requirements (all Category I to IV banking organizations with assets of $100+ billion), including applying a broader set of capital requirements to more large banks and standardizing certain aspects of the capital framework. The effect of the changes, which would implement the final components of the international capital standards (e.g., the Basel III agreement) in the US as well as markedly change the U.S. “tailoring rules” (e.g., impose more requirements on all Category II, III, and IV banking organizations), is expected to vary for each bank based on its activities and risk profile.
The regulators intend for changes to introduce more transparency, consistency, and risk sensitivity to the measurement of risk-weighted assets. Firms should anticipate regulatory focus across core risk areas (e.g., operational risk, credit risk, market risk) as well as business lines and corporate functions.
- Risk-Weightings: Adjustments to risk-weighted capital calculations include:
- Operational Risk: Standardized approach would use a function of firms’ “business indicator components” and “internal loss multipliers”.
- Credit Risk: Expanded risk-based approach with increased “risk sensitivity” from additional criteria and metrics for differentiation of credit risk within exposure categories and a broader range of risk weights for various asset classes (e.g., exposures to depository institutions, foreign banks, and credit unions; subordinated debt; real estate, retail, and corporate exposures).
- Market Risk: Standardized and internal model approaches for calculating risk-weighted assets for market risk; introduces the concept of a trading desk and restricts application of the models-based approach to the trading desk level.
- Credit Valuation Adjustment Risk: New, standardized approach allows recognizing hedges for expected exposure component of CVA risk.
- Securitization Exposures and Equity Exposures.
- Whole of Business: For all impacted institutions, changes to capital requirements will drive extensive changes in governance processes, data, models, system infrastructure, internal controls, and regulatory reporting, which will span both business lines and corporate functions over a multiyear timeframe. Further, firms (regardless of size) should anticipate that regulators may request information on practices and data that seem to be a “tier up” from current category levels.
Framework
Changes to the capital requirements will also impact:
- Stress Testing: Revised calculations under the proposed “dual-requirement capital structure with output floors” (i.e., a requirement that risk-based capital ratios be calculated under both the “expanded risk-based approach” and the “standardized approach” and the lower of the two be used for each risk-based capital ratio) will drive (re)assessment and (re)alignment of existing stress testing frameworks with the need for additional scenarios, including scenarios that consider the impact of rising rates on asset values, deposit stability, liquidity, and earnings.
- Capital Planning and Balance Sheet Management: Capital planning and balance sheet management strategies will evolve based on the new approaches/requirements; expect heightened data requirements, supervisory scrutiny of models, and more granular reporting.
- Accounting and tax: Changing capital plans, balance sheet management strategies, and corresponding adjustments will potentially result in changes to accounting and tax calculations (e.g., AOCI, DTA).
Risk management
In combination with economic uncertainties and interest rate pressures, changes to the capital requirements will focus supervisory attention to:
- Impacts and Metrics: Evaluation of the impact changed capital requirements would have on portfolios and products, as well as reassessment of risk management metrics and thresholds to align with evolving capital requirements.
- Unrealized Losses: Impact of potential new requirements to recognize unrealized losses on available-for-sale securities in regulatory capital and related changes to capital and liquidity risk management programs (see 04 Growth & Resiliency).
- Credit Vulnerabilities: Increasing risks (e.g., repricing, default) amidst rising interest rates, tightening of credit terms (e.g., loan size, maturities, collateralization, interest rate floors), and weaknesses in select sectors (e.g., urban commercial real estate—offices, hotels); regulators will look to stress testing and scenario analysis as ways to identify and measure the impact of credit vulnerabilities (e.g., concentrations, highly leveraged borrowers, lower-rated borrowers).
- Long-Term Debt: For large banks and BHCs (e.g., $100+ billion), plans to issue and maintain minimum levels of eligible long-term debt sufficient to absorb losses or to provide capital in a resolution (i.e., as required through an interagency rulemaking).
What to Watch
Regulatory attention, based on the proposed capital requirements, will focus on the impacts and implications to firms’ business processes, capital and risk calculations, and capital planning and investment strategies.
- Capital Requirements: Proposed “Basel III Endgame”: Interagency (FRB, FDIC, OCC) proposal to substantially change regulatory capital requirements impacting large banks with $100+ billion in total assets; the changes would implement final components of the Basel III agreement in the US as well as make changes to the US “tailoring rules.”
- Long-Term Debt Requirements: Interagency (FRB, FDIC, OCC) proposal to impose long-term debt requirements for certain large banks and holding companies with assets of $100+ billion.
Call to Action…
- Conduct current-state assessment: Evaluate the existing governance, data, data quality, models, system infrastructure, internal controls, regulatory reporting, and capital strategies to identify areas where remediation is needed considering the new capital requirements. Assess changes to regulatory reporting and build needed capabilities to include process, system, and technology changes. Start collecting data and perform pro forma RWA impact analyses on banks’ portfolios. Identify potential data gaps to support the proposed rules.
- Establish centralized coordination: Implement a coordinated approach to drive the various transition efforts across business lines and corporate functions, streamlining the process and ensuring compliance with the proposed rules.
- Optimize business and investment strategies: Banks should reconsider their strategies to comply with the new capital requirements—particularly in light of the impacts to various components including credit and operational risks (especially for larger, complex institutions)—paying particular attention to risk-sensitive areas such as high-leverage/ private equity exposures, resecuritization, and large trading activities.
- Prepare implementation and compliance timeline: Develop a comprehensive multiyear, firmwide plan to achieve compliance with the proposed rules, considering the transition period and the proposed compliance dates. Understand capacity planning to execute changes, specifically for data, analytics and modeling teams, which will be constrained as credit conditions continue to be volatile into 2024.
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Regulatory Insights
A source for updates and perspectives on regulatory activity and issues
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Amy S. Matsuo
Principal, U.S. Regulatory Insights & Compliance Transformation Lead, KPMG LLP
Adam Levy
Principal, Modeling & Valuation, KPMG US
Jeffrey Dykstra
Principal, Advisory, Financial Services Solutions, KPMG US
Amy S. Matsuo
Principal, U.S. Regulatory Insights & Compliance Transformation Lead, KPMG LLP
Adam Levy
Principal, Modeling & Valuation, KPMG US
Jeffrey Dykstra
Principal, Advisory, Financial Services Solutions, KPMG US