Incorporating Basel III reforms for stress testing

Late last month the Federal Reserve Board published two interim rules that explain specifically how banking institutions should apply Basel III reforms into their projections for the next round of capital plan submissions and stress tests. 

The information is important because the upcoming stress testing and capital planning cycle, which began on Oct. 1, will overlap with implementation of the Basel reforms. Planning for upcoming capital planning and stress testing will go through the fourth quarter of 2015. Meanwhile, depending on the size of the banking institution, Basel III reforms in the U.S. are expected to be implemented in 2014 or 2015. 

One of the rules allows for a one-year conversion period for institutions with between $10 and $50 billion in assets. These institutions are beginning their first round of stress testing following the Fed’s rules implementing the Dodd-Frank Act, and will be expected to calculate projections using current rules during these tests to provide them adequate time to modify internal systems for the revised framework.

The Fed’s other rule applies to banks with more than $50 billion in assets. These financial institutions must incorporate the revised framework into the next capital planning projections, and into the stress tests mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act using the transition paths established in the Basel III final rule.

Finally, the rules also explain that banks will not have to use advanced approaches in Basel III rules for calculating projected risk-weighted assets in a given cycle for capital planning and stress testing unless the institution has been notified by Sept. 30 of that year. 

For more information on stress testing approaches and methodologies, download the whitepaper Stress Testing: The Who, What, When and Why.