WASHINGTON, Dec 23 (Reuters) - The U.S. Federal Reserve announced on Monday that it is contemplating significant modifications to its annual bank "stress tests" following recent legal developments. These changes might include soliciting feedback from banks on the models and hypothetical scenarios utilized in the testing process, potentially averaging results over two years to mitigate annual volatility in reserve requirements. The stress tests, established after the 2007-2009 financial crisis, evaluate whether major banks can withstand economic disruptions, playing a crucial role in determining reserve amounts and shareholder payouts. The Fed emphasized that the proposed adjustments are not intended to impact overall capital standards, but are a response to evolving legal precedents affecting administrative law. These adaptations aim to enhance the tests' resilience in light of recent legal transformations.
In a landmark decision, the Supreme Court overturned a longstanding regulatory principle in June, eroding agencies' discretion in interpreting laws they enforce. The 2010 Dodd-Frank Act mandates balance sheet evaluations, yet the specific capital analyses performed by the Fed during stress tests are not legislatively mandated. The legal shift away from deference to agency interpretations, known as the Chevron doctrine, has raised concerns regarding the tests' susceptibility to legal challenges.
Amidst growing concerns, Wall Street banks and industry associations have been advocating for heightened transparency in stress testing methodologies. These endeavors coincide with broader industry initiatives aimed at tempering capital hikes, with prominent banks even threatening legal action against regulatory bodies. Suggestions for increased transparency have been met with cautious optimism by industry stakeholders, with one trade group praising the Fed's recent announcement as a positive step towards greater accountability. The Bank Policy Institute, a vocal critic of the stress tests, commended the Fed's decision and indicated a readiness to engage in further discussions to ensure that forthcoming reforms align with legal principles and industry best practices.
"We are reviewing it closely and considering additional options to ensure timely reforms that are both good law and good policy," said BPI President and CEO Greg Baer.