Fed working at cross purposes on stress-test development

09 January 2019 12:45 by Neil Roland

US Federal Reserve efforts to improve stress tests by measuring shocks to the whole financial system will likely be hobbled by a recent deregulatory law that shrinks the universe of available test data.

Fed Governor Lael Brainard said last month that the Fed is experimenting with ways to look at the impact not only of a direct jolt to a particular bank but also at “second-round” waves to it from other stressed firms and markets.

“The kind of systemic interactions we saw in the crisis are only imperfectly captured in stress tests,” she said.

But a Fed researcher has warned that a 2018 law that reduces the number of regional banks subject to stress tests, as well as the frequency of these exercises, could dilute the effectiveness of any systemic tests.

This law, Federal Reserve Bank of New York research director Beverly Hirtle said last summer, “could narrow the window that stress-test results provide on the build-up of risks and the loss-absorbing capacity of the banking system.”

She added: “Less of the banking industry will be covered by the stress tests, and assessments of the strength of the industry will be based on a smaller part of the whole.”

The US trails authorities in the euro area, Japan and Switzerland in running system-wide, or “macroprudential,” stress tests. However, these exercises are still in their “infancy,” a Bank for International Settlements report said last fall.

— 2018 law —

The 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act signed by President Donald Trump last May eased liquidity and stress-test standards for regional banks and large firms not deemed of systemic importance.

Last October, the Fed went further and proposed loosening these requirements for banks with $100 billion to $700 billion in assets.

More than a dozen banks — including US Bancorp, PNC and Capital One — would be affected. Last year, a total of 35 banks underwent stress tests.

Under the Fed proposal, banks with $100 billion to $250 billion in assets would no longer have to conduct company stress tests, and their government-run exercises would be moved to a two-year cycle, rather than annual. Banks in this category include SunTrust, BB&T and Fifth Third Bancorp.

Banks with $250 billion to $700 billion in assets that aren’t considered to be of global systemic importance would have to conduct company tests on a two-year cycle rather than semi-annually. They would remain subject to annual regulator-run exercises.

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