Stress Tests and Policy
This paper offers five observations about stress testing to help guide the recalibration of stress tests during peacetime. The five observations include, more widespread use of banks’ own models in stress testing, more transparency is not necessarily a good thing, slower adjustment to higher capital levels, maintain regular stress testing during peacetime, and increase the oversight of the migration of financial activity from banks to nonbanks.
Transparency and Model Evolution in Stress Testing
This paper evaluates how greater transparency affects the value of stress tests as a supervisory tool. The paper argues for changes to the models that compute pre-provision net revenue (PPNR) to make stress tests more countercyclical. As a result, the models used by the Federal Reserve should not be made public because by releasing all the information of the models it would make it quite difficult for the Fed to introduce new stresses through PPNR projections. Lastly, it argues the supervisory stress tests should incorporate additional market information.
Understanding the Effects of the U.S. Stress Tests
This paper provides a literature review of the effects of the U.S. stress tests on lending and also shows that stress tests are already highly countercyclical if one considers the proposed capital actions under CCAR. From that perspective, one way to make stress tests more countercyclical and help bank lending in the next recession would be to require banks to prefund all equity distributions in the derivation of each bank’s stress capital buffer. The paper also suggests the reduction of credit as a result of the stress tests may be a positive outcome since credit was oversupplied prior to the crisis but more research needs to be done to evaluate the trade-offs.
The Effects of Bank Capital Buffers on Bank Lending and Firm Activity: What Can We Learn from Five Years of Stress-Test Results?
This paper uses confidential supervisory data to analyze the impact of stress tests on C&I lending. The paper finds that banks with a larger capital depletion under stress lead them to reduce C&I lending materially. However, investment and employment of the affected firms appears to be little changed because firms substitute to other sources of credit. As a result, an activation of the CCyB would likely not have a meaningful impact in the overall debt volumes of firms.
Read More: https://www.federalreserve.gov/econres/feds/files/2019050pap.pdf
From Policy Rates to Market Rates—Untangling the U.S. Dollar Funding Market
This post investigates how changes in the interest rate paid by the Fed on reserves held by commercial banks affect rates in money markets in which the Fed does not participate. Using an interactive map, the authors illustrate the Fed is able to reach markets it does intervene through the web of interconnected relationships between both onshore and offshore participants and through a host of short-term financial products.
