August 7, 2020

Mr. David R. Casper

U.S. Chief Executive Officer and Group Head

BMO Financial Corp.

111 West Monroe Street 

Chicago, IL 60603

Subject: Response to request for reconsideration of the stress capital buffer requirement, 

pursuant to the Board’s capital plan rule

Dear Mr. Casper:

This letter is in response to the request by BMO Financial Corp. (“BFC”) for 

reconsideration of the stress capital buffer requirement provided to BFC by the Board on 

June 25, 2020. For the reasons stated below, the Board has affirmed the stress capital 

buffer requirement previously provided to BFC, incorporating adjustments made pursuant 

to 12 CFR 225.8(h)(2). 

I. Background

The Board’s capital plan rule1establishes the Board’s process for determining the 

stress capital buffer requirement applicable to a firm subject to the capital plan rule. 

Pursuant to that rule, the Board generally will provide a firm with notice of its stress 

capital buffer requirement by June 30 of each year in which the firm submits an annual

capital plan.

2

 On June 25, 2020, the Board provided BFC with notice that its stress 

capital buffer requirement associated with its 2020 annual capital plan submission is 

6.3 percent.

3

 

1

 12 CFR 225.8.

2

 12 CFR 225.8(h)(1).

3

 See email regarding 2020 CCAR Results (June 25, 2020).
- 2 -

The capital plan rule permits a firm to request reconsideration of the stress capital 

buffer requirement within 15 calendar days of receiving notice of the requirement.4 BFC

requested reconsideration of its stress capital buffer requirement on July 10, 2020. The 

capital plan rule generally provides that the Board will notify a firm of the Board’s 

decision to affirm or modify the firm’s stress capital buffer requirement within 30 

calendar days of receipt of the firm’s request for reconsideration, or within 30 days of the 

conclusion of an informal hearing regarding such a request.5

In each year in which a firm submits an annual capital plan, the Board generally 

will provide the firm with a final stress capital buffer requirement, as well as 

confirmation of the firm’s final planned capital distributions for that year, by August 31.6

Unless otherwise determined by the Board, the final planned capital distributions and 

final stress capital buffer requirement for a given year become effective on October 1 of 

that year.

7

 A stress capital buffer requirement that becomes effective will remain 

effective until superseded.8

II. Stress Testing Framework

The stress capital buffer requirement is established based, in part, on the results of 

a supervisory stress test conducted by the Board. Specifically, a firm’s stress capital 

buffer requirement is the greater of 2.5 percent or the following calculation: (1) the 

difference between the firm’s starting and minimum projected common equity tier 1 

(CET1) capital ratios under the severely adverse scenario in the Board’s supervisory 

stress test, plus (2) the sum of the dollar amount of the firm’s planned common stock 

dividends for each of the fourth through seventh quarters of the planning horizon9as a 

 

4

 12 CFR 225.8(h)(2)(i) and (j)(2).

5

 12 CFR 225.8(j)(5)(ii).

6

 12 CFR 225.8(h)(4)(i).

7

 12 CFR 225.8(h)(4)(ii)(A).

8

 12 CFR 225.8(h)(4)(ii)(B).

9

 The planning horizon is the period of at least nine consecutive quarters over which the 

relevant projections extend, beginning with the quarter preceding the quarter in which the 

firm submits its capital plan.
- 3 -

percentage of risk-weighted assets.

10

 The stress capital buffer requirement provided to 

BFC on June 25, 2020, was calculated based on 2020 supervisory stress test results 

released by the Board.11

The results of the Board’s supervisory stress tests are projected using a set of 

models developed or selected by the Federal Reserve that take as inputs (1) the 

supervisory scenarios created by the Federal Reserve and (2) firm-provided data on the 

firm’s financial condition and risk characteristics. To provide firms and the public with 

greater transparency regarding the Board’s process for designing supervisory scenarios 

for stress testing, in 2013 the Board finalized the Scenario Policy Statement.

 

10

 12 CFR 225.8(f)(2).

11

 See Board of Governors of the Federal Reserve System, Dodd-Frank Act Stress Test 

2020: Supervisory Stress Test Results (June 2020), available at 

https://www.federalreserve.gov/publications/files/2020-dfast-results-20200625.pdf. On 

February 5, 2019, the Board released materials intended to increase the transparency of 

the stress testing program. 

See https://www.federalreserve.gov/newsevents/pressreleases/bcreg20190205a.htm. 

First, the Board updated the Policy Statement on the Scenario Design Framework for 

Stress Testing (“Scenario Policy Statement”) to provide additional information regarding 

the path of home price variables, in particular, reducing uncertainty about the path of 

these variables in the severely adverse scenario. Second, the Board adopted a final Stress 

Testing Policy Statement to provide additional information about the Board’s principles 

and policies with regard to the development and validation of supervisory stress test 

models. See 12 CFR part 252, Appendix A. As described in the Stress Testing Policy 

Statement, material changes to the supervisory stress test models are phased in over two 

years to reduce year-over-year volatility stemming from updates to the supervisory 

models. The Stress Testing Policy Statement defines a model change as highly material 

if its use results in a change in the CET1 ratio of 50 basis points or more for one or more 

firms, relative to the model used in prior years’ supervisory exercises. See 12 CFR 252, 

Appendix B 2.3. This approach contributes to the stability of the results of the 

supervisory stress test by ensuring that changes in model projections primarily reflect 

changes in underlying risk factors and scenarios, year over year. Third, the Board 

provided additional information about the models used in the supervisory stress test. See

84 Fed. Reg. 6784 (February 5, 2019). The Board is committed to continuing to provide 

additional information, including modeled loss rates by loan and borrower characteristics, 

about its stress test models, as it has done most recently for its corporate loan and credit 

card models.
- 4 -

Consistent with the principles described in the Stress Testing Policy Statement, 

the Federal Reserve designed the system of models so they would result in projections 

that are (1) from an independent supervisory perspective; (2) forward-looking; 

(3) consistent and comparable across covered companies; (4) generated from simple 

approaches, where appropriate; (5) robust and stable; (6) conservative; and (7) able to 

capture the effect of economic stress.12

The Federal Reserve’s models rely on detailed portfolio data provided by firms 

but generally do not rely on models or estimates provided by firms, consistent with the 

modeling principle that emphasizes an independent perspective.

The Federal Reserve generally develops its models under an industry-level 

approach that is calibrated using data from many financial institutions. This approach 

reflects modeling principles that favor models resulting in consistent, comparable, and 

forward-looking projections. The Federal Reserve models the response of specific 

portfolios and instruments to variations in macroeconomic and financial scenario 

variables such that differences across firms are driven by differences in firm-specific 

input data, as opposed to differences in model parameters and specifications. As a result, 

two firms with the same portfolio receive the same results for that portfolio in the 

supervisory stress test, facilitating the comparability of results. In addition, the industrylevel approach promotes a forward-looking stress test, as it results in models that do not 

assume that historical patterns will necessarily continue into the future for individual 

firms. These policies also help to ensure that consistent and comparable supervisory 

models are forward-looking, robust, and stable.13

 

12

 See 12 CFR part 252, Appendix A.

13

 While the Federal Reserve limits the use of firm-specific fixed effects and the use of 

dummy variables indicating a loan vintage or specific year, it makes exceptions where 

appropriate. For example, the Federal Reserve may use firm-specific indicator variables, 

firm-provided estimates, or third-party models or data in instances in which it is not 

possible or appropriate to create a supervisory model for use in the stress test, including 

when supervisory data are insufficient to support an independently modeled estimate of 

losses or revenues. However, the Federal Reserve does not adjust supervisory projections 

for individual firms or implement firm-specific overlays in the supervisory stress test. 

This policy ensures that the supervisory stress test results are determined solely by 

supervisory models and firm-specific input data. The Federal Reserve has instituted a 

policy of not using additional input data submitted by one or more of the covered 
- 5 -

III. Discussion

As required by the Board’s capital plan rule, BFC’s request for reconsideration of 

its stress capital buffer requirement included a detailed explanation of why it contends 

that reconsideration should be granted.14 

To ensure that review of BFC’s request would be conducted with an independent 

perspective, a group of experts within the Federal Reserve System, who are independent 

of the staff who developed the models, analyzed the arguments made by BFC in favor of 

reconsideration of its stress capital buffer requirement.

15

 With respect to each of the 

issues raised in the request of BFC, the experts considered whether the request identified 

any errors in the firm’s stress test results and whether each stress test model identified in 

the firm’s request is operating as intended, within the bounds of the Board’s published 

policies. The information in this letter regarding the Board’s stress testing policies and 

supervisory modeling practices was previously publicly disclosed, consistent with the 

Board’s practice to increase the transparency of the stress testing program.16

In its request, BFC asserts that the Board’s pre-provision net revenue (“PPNR”) 

model (1) underestimated the firm’s trading revenues and (2) overestimated the firm’s 

non-interest expenses. With respect to each of these arguments, the Board has assessed 

BFC’s stress test results and Federal Reserve models for errors. Through this assessment, 

the Board did not identify any errors in BFC’s stress test results and has determined that 

the models operated as intended, within the bounds of the Board’s published policies.

 

companies unless comparable data can be collected from all the firms that have material 

exposure in a given area.

14

 See 12 CFR 225.8(j)(3)(i).

15

 This group is composed of staff members not involved in supervisory modeling, 

supplemented by subject-matter experts from across the Federal Reserve System. This 

group’s model validation process includes reviews of model performance; conceptual 

soundness; and the processes, procedures, and controls used in model development, 

implementation, and the production of results. See Board of Governors of the Federal 

Reserve System, Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Methodology

at 7 (March 2020), available at https://www.federalreserve.gov/publications/files/2020-

march-supervisory-stress-test-methodology.pdf.

16

 See supra note 11.
- 6 -

1. Trading Revenues

First, BFC argues that the supervisory model for trading revenue does not 

accurately capture the risk profile of its trading book, which changed significantly 

following the acquisition in 2018 of KGS-Alpha Capital Markets, L.P., and certain of its 

affiliates. In particular, BFC asserts that this portfolio consists of either U.S. Treasuries 

or U.S. agency-backed securities and that losses produced by the Federal Reserve’s 

supervisory model under the “global market shock” (“GMS”) (the trading and 

counterparty component of the stress tests) would more accurately reflect the risk profile 

of BFC’s trading assets and related revenue than the model used for firms not subject to 

the global market shock. 

The Board’s PPNR models are primarily estimated using data from the FR Y-9C 

and FR Y-14Q regulatory reports and data on historical economic conditions. Each 

autoregressive model for PPNR, including the model for trading revenue, includes both 

individual fixed effects and a trailing multiyear fixed effect to capture each firm’s 

average performance in recent years. Recent changes in a firm’s business model or 

performance are reflected in the projections through both changes in the recent average 

PPNR ratios and changes in lagged revenue or expense ratios. 

The Board has assessed its model for calculating trading revenues and did not 

identify any errors in BFC’s stress test results. In addition, the Board has determined that 

the model operated as intended, within the Board’s published policies. The Board notes 

that the supervisory trading revenue model for firms subject to the GMS, a PPNR model,

is designed for firms that are subject to the GMS, which applies a set of instantaneous, 

hypothetical shocks to a large set of risk factors. The model was not designed to apply to 

a firm like BFC that was not subject to the GMS. The Board also notes that it phased in 

an enhancement to its PPNR models this year, consistent with its Stress Testing Policy 

Statement, which increased the importance of firm performance in more recent years and 

diminished the degree to which quarterly volatility in historical PPNR affects projections

over the horizon. Accordingly, the Board has determined that it will follow its published 

principles for stress testing and not modify the existing results of its trading revenue 

model. 

2. Non-Interest Expenses

With respect to non-interest expenses, the firm argues that the Federal Reserve’s 

models overstate its expenses, in light of BFC’s strategic priority to reduce expenses and 

improve efficiency. Similar to the model for trading revenues, the models for non-
- 7 -

interest expenses are based on pro-forma historical regulatory data drawn primarily from 

data submitted on firm regulatory reports. Recent changes in a firm’s business model or 

performance are reflected in the projections through both changes in the recent average 

PPNR ratios and changes in lagged revenue or expense ratios. 

The Board has assessed its models for calculating non-interest expenses and did 

not identify any errors in BFC’s stress test results. In addition, the Board has determined 

that the model operated as intended, within the Board’s published policies. The models

are not designed to reflect a firm’s future strategic direction of cost-management 

decisions. As noted above, the Board’s recent enhancements to its PPNR models

increase the importance of firm performance in more recent years. Accordingly, the 

Board has determined that it will follow its published principles for stress testing, and not 

modify the existing results of its non-interest expenses models. 

IV. Conclusion

After consideration of the Board’s stress testing policies and all relevant facts, 

including the information provided in the request, and consistent with the Board’s 

regulations, the Board has determined to affirm the stress capital buffer requirement 

provided to BFC on June 25, 2020. The Board notes that it is focused on continuously 

improving the stress testing framework, including the Board’s supervisory models. With 

regard to the arguments raised by BFC, the Board has directed Federal Reserve staff to 

explore potential improvements through the use of more recent data for purposes of 

PPNR model development and estimation. In evaluating any of its supervisory models, 

the Board follows the processes for development, implementation, and validation of its 

supervisory models as outlined in the Board’s Stress Testing Policy Statement. 

The Board notes that BFC made adjustments to its planned capital distribution 

after receiving notice of its stress capital buffer requirement, consistent with the Board’s 

regulations.17 The final stress capital buffer requirement for BFC incorporates these 

adjustments, and is 6.0 percent. The Board hereby confirms that the final planned capital 

distributions BFC submitted as part of its 2020 capital plan submitted on April 5, 

incorporating any adjustments made pursuant to 12 CFR 225.8(h)(2), are final. BFC’s

final stress capital buffer requirement and final planned capital distributions are effective 

October 1, 2020. The Federal Reserve supports banking organizations that choose to use 

their capital buffers to lend and undertake other supportive actions in a safe and sound 

 

17

 12 CFR 225.8(h)(2)(ii). 
- 8 -

manner.18 When using their buffers, banking organizations may make capital 

distributions up to prescribed limits, which include automatic limitations in the capital 

framework, as well as any additional limitations determined by the Board.19 

Please contact Hillel Kipnis at (202) 452-2924 with any questions.

Sincerely yours,

Margaret McCloskey Shanks

Deputy Secretary of the Board

cc: John Haworth, Assistant Vice President

Federal Reserve Bank of Chicago

 

18

 See Interagency Statement on the Use of Capital and Liquidity Buffers (March 17, 

2020), available at 

https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200317a.htm. 

19

 A “capital buffer” refers to capital held above regulatory minimum 

requirements. Banking organizations with regulatory capital ratios that are below their 

capital buffer requirement face gradual restrictions on capital distributions and 

discretionary bonus payments. See 12 CFR 217.11(c). These restrictions encourage 

banking organizations to conserve capital within the organization as they lend to 

households and businesses and as their capital levels approach minimum regulatory 

capital requirements. Capital buffers were designed to provide banking organizations 

with the means to support the economy in adverse situations and to allow banking 

organizations to continue to serve households and businesses.