Federal Reserve scraps 'qualitative' test for U.S. banks in 2019 stress tests

WASHINGTON (Reuters) - The U.S. Federal Reserve said on Wednesday it would no longer flunk banks based on operational or risk management lapses during its annual health check of the country’s domestic banks.

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The “qualitative” portion of the 2019 test, however, will still apply to the U.S. subsidiaries of five foreign banks subject to the annual exam.

The move, which is a big win for major banks, such as Goldman Sachs Group Inc, Morgan Stanley and JP Morgan, Bank of America and Citigroup, forms part of a broader effort by the Fed to overhaul its annual “stress-testing” process, which the industry has long criticized as too onerous and opaque.

Since the 2007-09 global financial crisis, the Fed has put the country’s lenders through strict annual tests to see whether they would have enough capital to withstand a major economic downturn.

For the largest lenders, that test also included a so-called “qualitative objection,” that gives the Fed the discretion to fail banks due to risk management or operational failures, even if they have sufficient capital.

Most banks that have failed the tests in the past stumbled on the qualitative objection. Banks that receive an objection from the Fed are required to adjust their capital distribution plans.

On Wednesday, the Fed said it would eliminate the qualitative objection for most firms “due to the improvements in capital planning made by the largest firms” since the crisis.

Lenders which are still relatively new to the tests and may have “less established” capital planning capability would still remain subject to the qualitative test.

The Fed will still examine domestic banks for operational and risk management problems, but will address them through enforcement actions rather than a public flunking.

The U.S. subsidiaries of five foreign lenders - Deutsche Bank, Credit Suisse Group AG, UBS Group AG, Barclays Plc and TD Bank - would also still b subject to the qualitative objection.

TD Group would be potentially freed of the qualitative requirement beginning in 2020 assuming it passes in 2019, while the remaining banks would have to wait for the 2021 testing cycle.

Reporting by Michelle Price and Pete Schroeder; editing by Sonya Hepinstall and G Crosse