Financial Regulators Loosen Certain Rules on Banks While Introducing Other Restrictions

Chris Gaetano
Published Date:
Jun 26, 2020
Financial regulators have, on the one hand, loosened certain requirements of the Volcker Rule while, on the other, introduced new restrictions on banks in response to the most recent round of stress tests.

A group of regulators including the Federal Reserve, the Commodities Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of Currency and the Securities and Exchange Commission approved the Volcker Rule changes yesterday. The rule, instituted as part of the Dodd-Frank Act, generally prevents banks from engaging in proprietary trading with customer deposits, with certain exceptions. The new rules widen these exceptions. Now banks can invest in venture capital funds, credit funds, family wealth management vehicles and customer facilitation vehicles under certain conditions. Further, the new rules ease bank requirements on investing in foreign public funds, loan securitizations and public welfare and small business funds. They also loosen the limitations on how close a relationship can be between a bank and a covered fund (one that banks generally can't engage in proprietary trades with), narrow the definition of ownership stake in a covered fund, and ease the use of parallel investments in covered funds.

On the same day this relief was passed, however, the Federal Reserve also introduced new restrictions on banks due to the latest stress tests. The central bank tested how financial institutions would fare in a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession.

In aggregate, loan losses for the 34 banks ranged from $560 billion to $700 billion in the sensitivity analysis, and aggregate capital ratios declined from 12.0 percent in the fourth quarter of 2019 to between 9.5 percent and 7.7 percent under the hypothetical downside scenarios. Under the U- and W-shaped scenarios, most firms remain well capitalized but several would approach minimum capital levels. The sensitivity analysis does not incorporate the potential effects of government stimulus payments and expanded unemployment insurance.

As a result of these stress tests, the Fed said that large banks must suspend share repurchases in the third quarter and limit dividend payments to  an amount based on recent earnings, meaning that banks can pay out dividends only if they have sufficient income to do so. Further, it is requiring that all large banks resubmit and update their capital plans later this year to reflect current stresses, which will help firms reassess their capital needs and maintain strong capital planning practices during this period of uncertainty. The Fed will conduct additional analysis each quarter to determine if adjustments to this response are appropriate.

"The banking system has been a source of strength during this crisis," Vice Chair Randal K. Quarles said, "and the results of our sensitivity analyses show that our banks can remain strong in the face of even the harshest shocks."

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