Stay informed with free updates
Just register Financial and Market Regulation myFT Digest – delivered straight to your inbox.
The Federal Reserve is considering “significant changes” to annual stress tests for large U.S. banks that would reduce volatility in test results and make the process more transparent.
The Fed did not provide details on the changes, but said they could modify the model that calculates banks’ assumed losses, average the results over two years to reduce the risk of large year-over-year swings, and allow the public to comment on the assumed losses each year at the end of the year. Plans are evaluated before being finalized.
The Fed said the changes were not intended to “have a material impact on overall capital levels.”
“The administrative law framework has undergone significant changes in recent years,” the Fed said in a statement. “The Board analyzed the current stress tests in light of the changing legal environment and decided to modify the tests in important respects to increase their resilience.”
The Fed said the reform was in response to recent changes to the administrative law framework, which was overturned earlier this year when the U.S. Supreme Court overturned the so-called “Chevron deference” decision. The ruling limits the freedom of federal agencies to establish rules and regulations.
The testing’s transparency and uneven results have been a source of frustration for the banking industry. The Bank Policy Institute, an industry lobby group, welcomed the Fed’s announcement as a step toward “transparency and accountability.”
The stress test is an annual exercise for the largest U.S. banks, including JPMorgan Chase & Co. and Goldman Sachs. Their businesses were put through a series of doomsday scenarios to calculate the appropriate capital requirements for each lender. Capital is used to absorb potential losses.
The test is crucial to restoring confidence in the banking sector after the 2008 financial crisis. In recent years, however, it has lost much of the drama, with banks often easily escaping from well-capitalized hypothetical scenarios. Bank executives have also criticized the tests as being too opaque and producing volatile results.
Earlier this year, Goldman Sachs became the first U.S. bank to successfully challenge the Federal Reserve’s stress tests and ultimately cut its capital requirements.
The stress test changes could end up being another victory for the banking industry, which is already hoping for less implementation of the so-called Basel III final capital rules in a second Trump administration.
Initial plans for Basel reforms were announced last year by Fed Vice Chairman Michael Barr, but were scaled back due to resistance from the banking industry. The final outcome will be affected by the incoming Trump administration.
