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In Final Fed Speech, Tarullo Eyes Looser Stress Test Limits

Ronald Orol

In his final speech before leaving the Federal Reserve, outgoing Governor Daniel Tarullo suggested that regulators could further ease some restrictions on big banks subjected to annual stress tests.

At issue is the yearly Comprehensive Capital Analysis and Review, or CCAR, exam that determines the size of buybacks and dividends big banks can make for the next 12 months. The Fed weighs companies on both qualitative and quantitative grounds in the evaluation, and a number of the largest U.S. financial institutions have received "qualitative objections" in recent years over concerns around risk management. Last year, CIT  in July was one of them.

"The time may be coming when the qualitative objection in CCAR should be phased out, and the supervisory examination work around stress testing and capital planning completely moved into the normal, year-round supervisory process," Tarullo said at an event held at the Woodrow Wilson School at Princeton University.

He also suggested that it may be time to make changes to the Volcker Rule, which was included in the post-crisis Dodd-Frank Act as a mechanism to prohibit speculative proprietary trading. The governor argued that the Volcker Rule, as it has been drafted and implemented, is "too complicated" and may be hurting banks' market-making.

The comments by Tarullo, who led the Fed's banking supervision initiatives, may be a boon for shares of the biggest U.S. finance firms, from Bank of America  to Citigroup , Wells Fargo , Goldman Sachs  and Morgan Stanley  . A few of them have had to contend with limitations on capital distributions in the past.

Tarullo pushed back, however, on assertions that the stress tests should be detached from limitations on capital distributions.

"This would, in effect, make the stress test simply an informational exercise for supervisors and markets and would, accordingly, presumably be treated less seriously by all concerned," Tarullo said. "It would also reduce capital requirements for the largest banks, which may be one of the motivations for the idea."

It's possible that the Fed will follow Tarullo's recommendations in the months to come. Much will depend, however, on whom the Trump administration picks to head the central bank's supervision programs. At least three candidates, including Federal Deposit Insurance Corp. Vice Chairman Tom Hoenig, have been considered for the role, but the White House has yet to make its nomination. 

In his wide-ranging speech, Tarullo also recounted his experience as a regulator during the height of the financial crisis, noting that he was "stunned" in his first few months at the Fed to find out that many banks were unable to add up their total exposure to particular trading counterparties across many divisions in "anything like a reasonable time."

Some firms didn't even have ready access to basic information about the location and value of collateral that they held, he added. "As recently as a couple of years ago, we were still seeing some significant problems with data and modelling reliability in banks' internal risk-management processes," Tarullo said.

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