Revised test design proposed by the Fed
Federal Reserve Proposes Changes to Stress Tests for Big Banks
The Federal Reserve has announced plans to update its stress tests for big banks, aiming to enhance transparency and streamline the collection of related data. These changes are intended to improve the assessment of capital requirements under hypothetical adverse economic conditions, such as severe recessions and financial disruptions.
The proposed updates will lead to a more thorough evaluation of banks' capital adequacy under evolving risks, potentially impacting the capital that big banks must hold to absorb losses. The Federal Reserve has engaged industry stakeholders through conferences and notices of proposed rulemaking, demonstrating a commitment to incorporating feedback and increasing transparency in the process.
However, the proposed changes have not been met with unanimous approval. Some Federal Reserve governors, including Gov. Michael Barr, have expressed concerns, while banking trade associations like the American Bankers Association and the Bank Policy Institute have challenged aspects of the Fed's stress testing framework in court. Plaintiffs in ongoing litigation argue for assurances that reforms will be implemented without undue delay, emphasizing the importance of a stress testing framework that supports healthy lending.
Experts and insiders have also raised concerns, cautioning that the Fed relies too heavily on its own supervisory stress test models and should better incorporate banks' internal models to reduce concentration risk and improve accuracy.
The proposed changes include disclosing and seeking public comment on the stress test models. The public will also be able to comment on the hypothetical scenarios before they are finalized. The Federal Reserve plans to propose additional changes to stress-test transparency later this year.
One of the key objectives of these changes is to reduce year-over-year fluctuations in capital requirements. Currently, banks must meet their new stress capital buffer by October 1. The proposed changes aim to average results over two years and extend the date by which banks meet new capital buffer requirements.
Gov. Adriana Kugler has issued a notice in support of the Federal Reserve's proposed changes, but with concerns about weighting two years of data. She notes that the drawback of such proposed changes is that the stress capital buffer will be less sensitive to current economic conditions.
The lawsuit filed in the U.S. District Court for the Southern District of Ohio alleges that the stress-test models adopted by the Federal Reserve produce vacillating and unexplained requirements and restrictions on bank capital. Comments on the Fed's proposal are due 60 days after they're published in the Federal Register.
In summary, the proposed changes reflect a push toward more comprehensive and transparent capital stress testing. However, unresolved concerns remain about oversight, modeling approaches, and regulatory burden, fueling ongoing debate between regulators and industry stakeholders.
- The Federal Reserve's proposed changes to stress tests for big banks aim to improve the assessment of capital requirements in business and finance, particularly under adverse economic conditions.
- The public will be able to comment on the hypothetical scenarios used in the stress tests for big banks, as part of the process to enhance transparency in both the business and finance sectors.
