Fed Considers Changes to Bank Stress Tests

By Pete Schroeder
WASHINGTON (Reuters) – The U.S. Federal Reserve stated on Monday that it is contemplating significant adjustments to its annual bank "stress tests" due to recent legal developments. These changes may allow lenders to comment on the models used and hypothetical scenarios employed in the tests, marking a notable win for Wall Street banks.

The Fed indicated it might also consider averaging results over two years to mitigate annual volatility in the capital banks must reserve for potential losses.

Established in response to the 2007-2009 financial crisis, these tests evaluate whether major lenders can withstand economic shocks. They are essential to the U.S. capital framework, dictating the amount of cash lenders need to maintain for loss absorption and the capital they can distribute to shareholders.

The Fed emphasized that the proposed modifications aim not to alter overall capital requirements but stem from recent court decisions that have reshaped administrative law.

The Fed Board stated, "The (Fed) Board analyzed the current stress test in view of the evolving legal landscape and determined to modify the test in important respects to improve its resiliency."

In June, the Supreme Court significantly affected federal regulatory power by reversing a 1984 precedent that favored government agencies in interpreting laws, which originated from a case involving Chevron.

Although the 2010 Dodd-Frank law mandates the Fed to test banks' balance sheets, the capital adequacy analysis and the resulting capital reserves are not legally required. Analysts believe the elimination of Chevron leaves stress tests susceptible to litigation.

Wall Street banks and their lobbyists have been working discretely this year to enhance the transparency of stress tests, as shown by industry records detailing meetings with the central bank.

These discussions are part of a broader initiative to dilute the Basel Endgame capital increases, leading Wall Street banks to consider legal action against the Fed and other regulators involved.

Historically, banks have shown caution in suing federal regulators but are now more assertive as conservative courts increasingly side with industry claims against federal overreach.

The Bank Policy Institute, an industry trade organization critical of the tests, remarked that Monday's announcement is a "first step towards transparency and accountability."
BPI President and CEO Greg Baer stated, "We are reviewing it closely and considering additional options to ensure timely reforms that are both good law and good policy."