Washington, D.C. — Yesterday the Bank Policy Institute and American Bankers Association filed petitions for rulemaking with the Federal Reserve Board seeking release for public comment of both the supervisory models and stress scenarios that the Federal Reserve uses to calculate binding capital requirements through its annual stress tests. Those models and scenarios play a crucial role in setting minimum capital requirements for large banks, and as a result, have a direct effect on the availability and cost of credit across the economy. Nonetheless, to date the Federal Reserve has declined to seek public comment on its stress scenarios and has kept its supervisory models secret, in clear violation of the Administrative Procedure Act.
In their letter to the Fed announcing the petitions, the trade associations wrote:
“We believe that, by granting these requests, the Board can remedy the serious existing legal defects that currently undermine the credibility and effectiveness of the Board’s framework for setting stress-based capital requirements. In addition, granting these requests would acknowledge that the development of stress test models and scenarios is a complex and challenging task that could benefit from public review and a range of external perspectives, rather than relying solely on the views of the Board, its staff, and its private advisors.”
Since the conversion of the stress test to a binding capital charge in 2020, the Federal Reserve has made periodic commitments to enhance the transparency of its process. However, it has instead continued its policy of secrecy, even as its stress test has produced persistently volatile and counterintuitive outcomes. Thus, substantial year-to-year fluctuations in banks’ capital levels appear to stem from unexplained changes in Fed modeling rather than changes in the financial risks of the banks themselves. As a consequence, banks must hold additional capital to account for the uncertainty inherent in the Fed’s models, and they pass this cost on to households and business borrowers in the form of more expensive and less available credit.
Problems associated with the opacity of the stress test are only exacerbated by the forthcoming proposal to implement the 2017 Basel Accord. That proposal is expected to make major changes to capital requirements for operational and market risk and will be published for public comment. But informed comment will be impossible for the public to make without understanding how the Fed’s stress test models set minimum capital requirements against those same risks.
“There is no legal justification for the Federal Reserve to continue to calculate large bank capital requirements with rules that are developed and applied in secret,” said Greg Baer, CEO of the Bank Policy Institute. “No other agency of government operates in this way: the IRS sends out tax bills based on a published code, not a secret model that determines each taxpayer’s liability; speed limits are posted and consistent, not hidden or constantly varying in erratic ways to force drivers to go much slower because they don’t know what they are.”
“The stress testing program remains unnecessarily opaque even though the high stakes for banks and the economy are crystal clear,” said ABA President and CEO Rob Nichols. “The choices the Federal Reserve makes in its models and scenario assumptions can directly affect credit availability and have a meaningful impact on economic growth and job creation. Given the implications, the Fed should welcome more public input and embrace greater transparency. These petitions advance both.”
The Administrative Procedure Act was enacted on the assumption that transparency and public input produces better government rules. Nowhere is that more the case than with the challenging task of modeling financial risk. That process would greatly benefit from public review and a range of external perspectives, instead of leaving sole, unaccountable power in the hands of a single Federal Reserve governor and Federal Reserve Board staff.
The petition for rulemaking is a statutory mechanism under the Administrative Procedure Act that allows any interested person to petition an agency to commence rulemaking. Agencies are required by law to respond, and any denial of a petition for rulemaking is subject to judicial review under the APA.
The legislative history of the Administrative Procedure Act states “the law must provide that the governors shall be governed, and the regulators shall be regulated, if our present form of government is to endure.” Nowhere is this more true than with respect to a capital rule that affects the access and price of credit for every person and business in the United States.
About Bank Policy Institute.
The Bank Policy Institute (BPI) is a nonpartisan public policy, research and advocacy group, representing the nation’s leading banks and their customers. Our members include universal banks, regional banks and the major foreign banks doing business in the United States. Collectively, they employ almost 2 million Americans, make nearly half of the nation’s small business loans, and are an engine for financial innovation and economic growth.
About the American Bankers Association.
The American Bankers Association is the voice of the nation’s $23.7 trillion banking industry, which is composed of small, regional and large banks that together employ more than 2.1 million people, safeguard $18.7 trillion in deposits and extend $12.2 trillion in loans.