On November 11, 2020, Better Markets filed a comment letter on a proposed rule from the Federal Reserve which would amend the capital planning and stress testing requirements for certain large banks. This proposal is nominally designed to conform the capital planning and stress testing requirements with other changes to the prudential requirements applicable to larger banks recently made by the Board and other regulators. However, there are aspects of the proposal which would themselves increase systemic risk. More importantly, the proposal represents a missed opportunity to revisit a larger collection of dangerous deregulatory measures applicable to large banks and to restore important requirements that promote bank safety and soundness and systemic financial stability.
The 2008 financial crisis was exacerbated by widespread uncertainty about the financial wellbeing of our nation’s largest banks. To control this uncertainty, the Federal Reserve conducted stress tests of these banks, which sought to determine how the banks would fare in the case of further market downturns. By publishing the results of these tests, the Federal Reserve calmed the panicking markets and allowed investors to make informed decisions, which facilitated a return to financial stability. Recognizing the importance of stress testing to the twin goals of ensuring the capital adequacy of large banks and building public confidence by providing sufficient transparency into their condition, the Dodd-Frank Act required that banking regulators finalize rules requiring that the largest banks undergo regular stress tests. Unfortunately, under the Trump administration, the regulators have made a series of changes that undermined the credibility of the stress tests and weakened public accountability of the regulators administering the tests.
This proposal would further weaken the stress tests and the capital buffer framework they underlie. Among other changes, this proposal would allow banks with between $100 and $250 billion in assets to undergo supervisory stress tests only every other year; relieve them of the duty to use Fed-provided scenarios when developing their own capital planning projections; require only semi-annual updates to the stress capital buffer, except for the component based on planned dividends; and undermine comparability and public confidence in stress tests by allowing these banks to elect to undergo a supervisory stress in off-years, should they deem it advantageous to do so.
At a time of unprecedented financial instability, it is more important than ever that the public have faith in the safety and soundness of the nation’s largest banks. The Federal Reserve should withdraw this proposal and reassess its misguided approach to stress testing.
Read our full comment letter here, or by clicking the button below.