Key facts
- The Federal Reserve plans to consider a final version of its revamped bank stress test in the coming weeks.
- The changes aim to make the stress test process more transparent and the results more predictable for banks.
- The new process will provide more details on the Fed's models, including equations and variables.
- The Fed will also provide more information on the hypothetical economic scenarios used in the tests.
- The Fed plans to average the results of a bank's two most recent stress tests for capital requirements.
- The public will be able to comment on the testing models going forward.
Federal Reserve Vice Chair for Supervision Michelle Bowman announced that significant changes to the central bank's stress test for large banks are forthcoming. The overhaul, expected to be finalized in the coming weeks, aims to bring greater transparency and predictability to the process, which has long been a point of contention for the banking industry.
Banks have frequently complained that the stress tests, implemented after the 2008 financial crisis to set additional capital requirements, are subjective and burdensome. The industry even sued the Fed in 2024 over the use of these tests. Bowman stated that the revised framework will shed more light on the Fed's internal models, including the equations and variables used to identify potential weaknesses, details that have historically been kept confidential.
Furthermore, the Fed intends to offer more clarity on the hypothetical economic scenarios employed annually for the tests, a move designed to enhance public understanding. A new rule will also be adopted to average a bank's two most recent stress test results when determining its "stress capital buffer," a measure aimed at reducing volatility in the capital banks must hold. The public will have the opportunity to comment on the testing models, and the Fed plans to use the stress testing process to inform supervisors about potential bank weaknesses through open dialogue with banks.
Bowman's review, conducted by consultancy Starling Trust Advisors, suggested that a "culture of risk aversion" among examiners, rather than relaxed oversight, contributed to the collapse of Silicon Valley Bank. This finding contradicts some conclusions from a prior postmortem led by Fed official Michael Barr. Bowman stated that Fed supervisors knew or should have known about SVB's vulnerabilities a year before its collapse but failed to take "prompt and decisive action." She attributed this inaction to the risk-averse culture among examiners and a lack of clear Fed decision-making.
Senator Elizabeth Warren criticized Bowman's findings as an "embarrassing attempt to re-write history designed to pave the way for more dangerous deregulation." Barr's earlier report had suggested examiners felt pressured to go easier on banks, particularly after a 2018 law eased rules for many lenders. Quarles, Barr's predecessor, has disputed this, stating supervisors were encouraged to focus on liquidity and deposit concentration risks.