For a select few big banks on Wall Street, the toughest part of the Federal Reserve’s stress test isn’t the first part — a series of mathematical models through which banks have to prove they have sufficient capital — or the second part, where regulators judge them on the work they put into capital planning.
For them, the hard part is dealing with Dan Tarullo.
That’s probably just how Tarullo, a member of the Federal Reserve’s Board of Governors who is viewed as a driving force behind difficult regulatory requirements, wants it. The Obama Administration appointee tasked with overhauling the inadequacies of the Federal Reserve has been, according a WSJ report last week, gutting the authority once held by the US central bank’s New York branch and redistributing it in Washington, rankling those within the Fed and some on Wall St. as well.
Winning the power struggle
“Dan has done an effective job of wresting power from [the] New York [branch],” one banking source opined.
After the White House tapped Tarullo in the wake of the financial crisis to improve oversight, increase accountability and reduce systemic risk on Wall St., the Democrat appointee has reportedly been bulldozing over cozy relationships between regulators and banks, keeping his colleagues and top bankers alike on their toes. That includes naming the biggest risks to the US financial system, and keeping their feet to the fire.
The shift in the balance of the power at the Federal Reserve, under what has been dubbed the Triangle Document, first began to take shape in 2010. However, the policies created by the document, which is not yet available for public viewing, have been in place for five years. The document established the Large Institution Supervision Coordinating Committee (the LISCC), which is a post-crisis reorganization of how the Federal Reserve supervises the largest, most critical financial institutions.
Not every bank required to submit capital plans has to submit to LISCC inspection, just ones that might pose greater risk to US financial stability in the event of a crisis. This includes banks like Citigroup, Deutsche Bank, Goldman Sachs, Morgan Stanley and JP Morgan, but not smaller community banks, like M&T.
In a 2011 speech, Ben Bernanke, then still Fed chairman, said the LISCC aims to employ “quantitative methods for evaluating the health and performance of supervised firms as well as the risks they may pose to the broader financial system.”
According to the Fed’s website, the LISCC has four core areas of focus:
“1. Capital adequacy and capital planning;
2. Liquidity sufficiency and resiliency;
3. Corporate governance (assessing the effectiveness of senior management and boards of directors); and
4. Recovery and resolution planning.”
More transparency, more oversight, less risk-taking under Tarullo
Tarullo has been a harsh critic of Wall St., so it should be regarded as little surprise, especially among those who have spent years interacting with him in that role, that he is eager to implement more oversight on banks and transparency on the Federal Reserve itself.
In a 2014 speech, he assailed Wall St. culture as lending itself to excessive risk taking:
“[i]f a financial firm’s recruitment of young professionals is driven almost entirely by promises of the large amounts of money they can make and the speed with which they can make it, then the firm should not be too surprised when those same young professionals give short shrift to values such as respect for customers, or skirt risk-management guidelines, or perhaps even ignore regulatory and legal compliance requirements.”
Tarullo did not respond to requests for comment.
Ever since being President Barack Obama’s first appointee to the central bank’s board of governors in 2009, Tarullo has fought to follow through on pledges he made early on in his role at the Federal Reserve: providing consumer protection, redesigning supervisory processes and beating back systemic risk, at individual banks and across the industry.
Some argue that he is a needed change for the Federal Reserve after decades in which its relationship with Wall St. became deeply tangled under the leadership of Alan Greenspan. Others view him as ‘bully,’ according to one report, who is reticent to accept other Fed members’ views — particularly those who Tarullo views as having failed to safeguard against the most recent financial crisis.
Some point out that there has been no crisis on Tarullo’s watch, others suggest he may be the single most powerful force within the Fed fighting to prevent one from returning.
Banks are sweating the results of the round 2 stress test coming Wednesday
Last week, the Federal Reserve announced that all 31 banks participating in the first portion of its annual stress test had passed. That portion of the Fed test included various models factoring in a number of metrics, like unemployment, and how worsening macro factors would impact banks’ capital reserves.
On Wall St., the second round of the Fed’s test are regarded as more difficult — and more abstract — than the first round. That has invited the criticism of some in the financial services community who called oversight mechanisms being implemented by regulators burdensome and unnecessary. And the results are on their way tomorrow.
Wednesday, the market will see which banks passed its second portion, determining who can process dividends to shareholders, and in some cases, buybacks, and which banks’ shareholders will have to sit out a bigger cash distribution. It is said some shareholders may pursue CEOs’ resignation, should they again disappoint; elsewhere, activists are said to be sharpening knives and rhetoric in anticipation of the next breakup target.
For the last few months, bank holding companies and international banks with US arms have been scrambling to satisfy the Federal Reserve’s test, adding staff and spending hundreds of millions in the process. A recent WSJ report signaled HSBC Holdings dedicated $US2.4 billion — a sharp increase — to global regulatory and compliance costs; Citigroup has reportedly spent $US180 million on various testing models that it hopes will satisfy the Fed’s stress test. Both banks failed a portion of the 2014 examinations. Others on Wall St. decline to disclose their regulatory compliance costs, broken out by what is spent satisfying the Fed.
It appears that, on Wall St., there is little appreciation for the Triangle Document, or the LISCC, especially at institutions where bankers have complained in the past about other regulatory headaches getting in the way of their top line, including directives issued from the Treasury Department. Still, one source indicated, bankers seem to have anticipated the discord between Fed branches.
“New York and Washington have never really gotten along,” the person said.
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