Bank Stress Test Overhaul Under Consideration by US Fed

Image Credit: The Economics Times

The U.S. Federal Reserve announced on Monday that it is considering significant changes to its annual bank "stress tests," responding to recent legal developments, and offering a major win for Wall Street banks.

The Fed stated it might allow lenders to provide feedback on the models used in the tests, as well as the hypothetical scenarios employed in the evaluations. Additionally, it may average the test results over two years to reduce volatility in the capital requirements that banks must set aside for potential losses.

Originally introduced after the 2007-2009 financial crisis, the stress tests assess whether large banks can withstand economic shocks. These tests play a crucial role in the U.S. capital framework, determining how much capital banks must hold to cover losses and how much they can return to shareholders.

The Fed emphasized that the proposed changes would not affect overall capital requirements but were prompted by recent court rulings that have reshaped administrative law. The Supreme Court's June decision overturned a 1984 precedent, which had previously directed courts to defer to federal agencies' interpretations of ambiguous laws. This shift has made the stress tests more susceptible to legal challenges, especially since the capital adequacy analysis conducted by the Fed during these tests is not mandated by law.

Wall Street banks and their trade groups have been lobbying for more transparency in the stress tests, according to industry sources and meeting records. This effort is part of a broader push to reduce the impact of the Basel Endgame capital hikes, with banks even threatening legal action against the Fed and other federal regulators involved in drafting the rules.

While banks have historically avoided suing regulators, recent conservative-leaning courts have shown more openness to industry arguments about overreach by federal agencies.

The Bank Policy Institute, a vocal critic of the stress tests, welcomed the Fed’s announcement as a step toward greater transparency and accountability. Greg Baer, President and CEO of the BPI, stated that the group would review the proposal and explore further actions to ensure timely reforms that align with both legal standards and good policy.

Paraphrasing text from "Reuters" all rights reserved by the original author.