Fed’s versus banks’ own models in stress testing: what have we learned so far?

Fed’s versus banks’ own models in stress testing: what have we learned so far?

The Clearing House  (TCH) published a new research note, “Fed’s versus banks’ own models in stress testing: what have we learned so far?” that analyzes the results of the supervisory stress tests obtained using the Fed’s models relative to the results obtained using banks’ own models under the Dodd-Frank Act stress tests over the past 5 years. The analysis finds: (i) banks’ projections of pre-tax net income are on average more pessimistic than the Fed’s projections, particularly for revenues under stress; (ii) the Fed projects that asset and loan balances grow over the stress horizon, with a resulting increase in risk-weighted assets, while banks assume that their balance sheets shrink due to a decrease in loan demand during a severe recession, with a resulting decrease in risk-weighted assets; and (iii) the disagreement between banks’ own projections and the Fed’s are persistent but only predictable in part.