WASHINGTON, D.C.—Phillip Basil, Director of Banking Policy at Better Markets, released the following statement in response to the Federal Reserve’s release of stress capital buffer requirements for the largest banks on August 5, 2021:
“The Federal Reserve’s recently released stressed capital buffers (SCBs) will provide the public, policymakers and elected officials false comfort that those banks have enough capital. That’s because those buffers are based on the Federal Reserve stress tests, which have been weakened over the last three years and no longer sufficiently stress or test Wall Street’s biggest banks.
“This is critically important because the only thing standing between a failing bank and a taxpayer bailout is the quantity and quality of capital that a bank has to absorb its own losses. That’s why regulators must ensure that the biggest banks have enough capital, which robust stress tests are supposed to help determine. However, if stress tests are weakened, as they have been, then those banks will not have enough capital, which will make their failure, a financial crash, and bailouts more likely.
“That is proved by the fact that there have been virtually no changes in the SCB even though the economy has been shut down and the financial system has been under unprecedented stress due to the worst pandemic in 100 years. Yet, the recently published 2022 SCB requirements generally showed little change from the 2021 requirements (just six increases across 34 banks, only two of which were material). That change was about the same as between the 2021 and 2020 requirements (about half the banks having their SCB requirement set to the floor of 2.5 percent and no material change for the largest, most systemically important banks).
“The Fed thinks this is good because it has a goal of making the stress test results and the SCB more stable and predictable for the biggest banks, but that has in fact contributed to a weakening of the stress capital requirements and the capital planning process. It is the wrong goal. Stability in the stress test results likely means the Fed is not stressing different risks each year, a critical feature of a robust stress test. Without this, the banks, the Fed, and the public are less informed of the range of risks that are present at these banks, and it risks Wall Street’s biggest banks not being appropriately capitalized to these risks. It also allows these banks to more easily game the SCB requirement by structuring their positioning to reduce the Fed’s loss estimates and plan to what they expect as their SCB requirement instead of following their own capital planning processes.
“Along with the other ways in which the Fed has dangerously weakened the stress test and capital planning programs, this more subtle method is also proving to be effective at further weakening these programs. The Fed must restore the stress in the stress test to ensure more meaningful stress-related capital requirements.”
Better Markets is a non-profit, non-partisan, and independent organization founded in the wake of the 2008 financial crisis to promote the public interest in the financial markets, support the financial reform of Wall Street and make our financial system work for all Americans again. Better Markets works with allies – including many in finance – to promote pro-market, pro-business and pro-growth policies that help build a stronger, safer financial system that protects and promotes Americans’ jobs, savings, retirements and more. To learn more, visit www.bettermarkets.com.