Washington, D.C. — The Federal Reserve should avoid unnecessary uncertainty in its proposed changes to the stress tests that determine banks’ capital requirements, BPI and the U.S. Chamber of Commerce Center for Capital Markets Competitiveness said in a comment letter filed today. The proposal, the first measure in a broader ongoing effort by the Fed to improve transparency in its stress testing framework, marks progress but requires key changes (including to resolve certain timing considerations) to align with its goal of mitigating uncertainty and volatility.
“This proposal is a constructive first step in improving the stress tests, but more work remains to be done,” said Sarah Flowers, BPI senior vice president and senior associate general counsel. “The Fed should resolve the uncertainty caused by the intersecting timelines of this pending proposal and release of the stress test results, as well as adjust the proposal so that when banks take appropriate actions to reduce risk, their capital requirements go down and their lending capacity goes up.”
Big picture: The proposal, which would average the results of bank stress tests in an effort to mitigate volatility in capital requirements, is a first step in the Fed’s commitment to improve the stress testing framework by subjecting it to public input. BPI and co-plaintiffs filed a legal challenge in December 2024 seeking full transparency on the Fed’s stress test models and scenarios, given their crucial role in shaping the cost of credit and financial intermediation in the U.S. economy. The Fed has committed to improving the framework, fully disclosing the models and subjecting the models and scenarios to public comment, and the Fed agreed in May to a temporary pause in the legal proceedings until Aug. 1, 2025.
Necessary changes: The letter urged the Fed to make several key changes that would align the averaging proposal with its intended goal of reducing volatility in banks’ capital requirements.
- Resolve the time crunch, and avoid uncertainty: The comment period on the proposal ends today, shortly before banks receive the results of the latest stress tests on June 27. Soon after the results are released, banks generally announce their indicative stress capital buffer requirements and planned capital distributions, which are shaped by the capital requirements. Because of the timing of the proposal, firms will not know if their indicative SCBs announced shortly after the comment period closes, which will presumably be based on the current rule’s calculation, will in fact be the SCBs in effect on October 1. This introduces considerable uncertainty in the process, underscoring the necessity of finalizing the rule in a timely manner.
- Prevent unnecessary volatility and costs to credit: The proposal’s purpose is to mitigate volatility in the stress capital buffer requirements that are determined by the stress test results. However, averaging two years’ worth of results only accomplishes this goal if it is applied in one direction – when a bank’s capital buffer requirement is set to increase, not decrease. The abrupt costs that the proposal is designed to address are only incurred with increasing capital requirements, not decreasing ones. Banks that have a decrease in their SCB should be allowed to fully recognize it (rather than averaging it with the prior year’s results and dampening the decrease effect) and thereby free up capital to lend, intermediate in capital markets and otherwise support the economy. The Fed should also avoid unduly high capital requirements that would result from averaging future results with those derived using current methods.
- Eliminate the dividend add-on. This component of the stress capital buffer calculation is unnecessary and rendered duplicative by other restrictions on banks’ dividend payouts when their capital levels are insufficient.
Today’s letter also made general comments on the stress testing framework, in addition to specific comments on the averaging proposal:
- Provide full transparency on stress test models and scenarios, and subject them to public comment.
- Make necessary improvements to the pre-provision net revenue model components — a critical change to address weaknesses in the models.
- Establish, by rulemaking, the framework for the design of the stress test scenarios, including defined design parameters of all components of the supervisory stress scenarios and any additional components or scenarios.
- Recognize the value of collateral and other risk-mitigating factors in credit and loan loss forecasting models and balance sheet assumptions.
- Resolve overlaps in the Basel capital framework and stress testing.
To access a copy of the letter, please click here.
###
About Bank Policy Institute.
The Bank Policy Institute is a nonpartisan public policy, research and advocacy group that represents universal banks, regional banks and the major foreign banks doing business in the United States. The Institute produces academic research and analysis on regulatory and monetary policy topics, analyzes and comments on proposed regulations, and represents the financial services industry with respect to cybersecurity, fraud, and other information security issues.
Media Contacts
- Tara Payne, Bank Policy Institute, tara.payne@bpi.com
