Washington, D.C. – The Bank Policy Institute (BPI) issued a statement on the 2024 stress tests conducted by the Federal Reserve, highlighting several concerns about the process and its implications for banks.

“Yesterday, it was widely noted that the nation’s largest banks had passed the Federal Reserve’s stress test. This reflects a continuing misunderstanding of that test, which is unsurprising, given its opacity and complexity,” BPI stated.

The organization clarified that since 2020, the results of these tests are not merely pass-fail grades but are used to calculate additional binding capital charges on covered banks. According to BPI, this year's test resulted in increased capital requirements for over half of the banks involved. About one-third saw increases of 70 basis points or more, while five banks experienced increases exceeding 200 basis points. BPI criticized the lack of transparency in the Federal Reserve Board models used to determine these charges.

“A bank ‘passing’ the test simply means that it is not required to raise capital or shrink assets immediately,” BPI explained. “But banks passed because they now all hold large excess capital as an uncertainty buffer given the randomness of each year’s test results.”

BPI emphasized that for those banks without capital increases, holding such buffers was unnecessary and could have been allocated to fund more loans or used for share repurchases.

In addition to addressing this year's stress test outcomes, BPI called for greater transparency in stress test models and scenarios. Francisco Covas from BPI testified at a House hearing this week advocating for public comment opportunities on these models.

Covas pointed out significant challenges with the Fed's projection of net revenues—a major component affecting banks' performance in stress tests—due to undisclosed modeling methods and reliance on aggregated models. He argued that these projections lead to large fluctuations in capital requirements year-over-year, complicating efficient capital allocation by banks.

“The substantial increases in capital requirements for subsidiaries of foreign banks operating in the U.S. raise questions about consistency and fairness across different types of banking institutions,” Covas added.

During his testimony, Covas highlighted overlap between current stress tests and other regulatory frameworks like Basel III Endgame proposals. He noted that both account for operational risk and market risk, effectively resulting in double counting some risks.

Covas also discussed how uncertainty stemming from volatile stress test results leads to underinvestment in small businesses and cyclically sensitive activities due to conservative capital holding practices by banks.

Responding to Rep. John Rose (R-TN), Covas suggested that failing to solicit public comments on stress test models might violate administrative law since these requirements function similarly to formal rules subject to notice-and-comment procedures.

Covas proposed enhancing transparency by incorporating more granular data into Fed's models and engaging with industry experts similar to processes followed under Basel Endgame regulations.

Finally, he raised concerns about due process within current reconsideration requests related to stress capital buffers since their implementation in 2020 has seen eight requests with no clear explanations provided upon apparent denials.

The Bank Policy Institute represents universal banks, regional banks, and major foreign banks operating within the United States. It conducts research on regulatory policies while advocating cybersecurity measures among other issues relevant to financial services industries.

For further information:

Tara Payne

Bank Policy Institute

tara.payne@bpi.com