Fed advances proposal to add transparency to large bank stress tests

The Federal Reserve today voted 6-1 to advance proposed rulemaking to make stress tests for large banks more transparent and give the public more opportunities to comment on the models used in the tests.

According to a board memo, the proposal would require the Fed to annually disclose the model documentation and scenarios, as well as seek public comment on any material changes to the models. It would also shift the jump-off date of the stress test from Dec. 31 to Sept. 30.

The proposed changes come after the American Bankers Association joined the Ohio Bankers League, Bank Policy Institute and other industry groups last year in a lawsuit challenging the stress testing framework for being too opaque. Fed Vice Chair for Supervision Michelle Bowman said that while she was happy the changes are moving forward, she was disappointed it took a lawsuit to spur the Fed board into action.

“Since its inception, the board’s stress testing program has operated with limited transparency, unreasonable year-over-year volatility, and the absence of any meaningful appeals process,” Bowman said. “These issues come as no surprise — we have been aware of these concerns for many years.”

Fed Governor Michael Barr was the lone dissenter, arguing that the proposed changes “will lead to overly optimistic projections in the stress test, both because of less conservative modeling choices and because of the potential for gaming by banks.”

In a joint statement after the vote, ABA and the other plaintiffs in the lawsuit said the proposal means anyone will be able to review the models used and provide feedback on how they could be improved to better reflect risk.

“The flaws in supervisory models and lack of transparency have caused unnecessary volatility in capital requirements and imposed unwarranted costs on the economy by reducing market liquidity, limiting the availability and increasing the cost of credit, and ultimately slowing job creation and economic growth,” they said. “Today is not just a good day for the rule of law but also a good day for economic growth.”