Bernanke Defends Confidentiality of Stress Test Calculations
In its second round of stress tests in two weeks, the Fed rejected two banks' capital plans — Ally and BB&T — while it found weaknesses in two others, JPMorgan Chase and Goldman Sachs.March 14
Despite companies' strong performance in the Federal Reserve capital simulations mandated by the Dodd-Frank Act, stress tests for the largest banks have really only just begun.March 7
WASHINGTON — Federal Reserve Board Chairman Ben Bernanke said Monday the central bank should not disclose the models it uses in its stress test exercises of the largest U.S. financial institutions.
Despite criticism by bankers that the Fed's models are kept in a "black box," Bernanke stressed the importance of avoiding a "model monoculture" that would be "susceptible to a single, common failure."
"The differences in stress test results obtained by supervisors' and banks' own models can be informative, and we do not want inadvertently to destroy the healthy diversity or innovation of the models and other risk-management tools used in the banking industry," said Bernanke, in prepared remarks at a conference hosted by the Federal Reserve Bank of Atlanta.
His remarks come weeks after the Fed released results of its latest stress exercises. The Fed approved capital plans of 16 of the 18 largest banks, rejecting proposals put forward by Ally Financial and BB&T. Separately, the central bank also asked JPMorgan Chase and Goldman Sachs to take a second look at their capital plans, citing weaknesses, but it gave them conditional approvals to move forward.
Bernanke noted the evolution of the Fed's annual stress tests exercises, which are meant to check whether banks' capital and liquidity positions are resilient enough to withstand prolonged periods of economic stress while still continuing to lend. Banks, for example, are now required to disclose their own estimates of potential losses and revenues.
Such disclosures, Bernanke said, will give investors and analysts an "alternative perspective" on the test results, while also helping them assess a bank's appetite for risk and its risk-management practices.
"Even outside of a period of crisis, the disclosure of stress test results and assessments provides valuable information to market participants and the public, enhance transparency, and promotes market discipline," said Bernanke.
Still, he acknowledged the criticism by bankers of the lack of disclosure of the central bank's models, but tried to illustrate various ways the Fed has been gradually improving its process through changes to its own models and data collection.
"We agree that banks should understand in general terms how the supervisory models work, and, even more importantly, they need to be confident that our models are empirically validated and sound," said Bernanke.
But bankers, he said, will gradually develop more confidence in the process as the Fed continues to make improvements.
"Over time, we expect banks to better understand the basic elements of the supervisory models, rendering them at least somewhat opaque," said Bernanke.
For example, in the most recent stress test exercise, Fed officials collected and analyzed loan and account level data on more than two-thirds of the $4.2 trillion in projected accrual loans and leases, he said. The data included borrower, loan, and collateral information on more than 350 million domestic retail loans, such as credit card and mortgages, and more than 200,000 commercial loans, according to the chairman.
The Fed used more than 40 models to project how categories of bank losses and revenues would likely respond in hypothetical scenarios, and that process is constantly evolving and improving with the help of experts both inside and outside of the Fed.
"These ongoing efforts are bringing us close to the point at which we will be able to estimate, in a fully independent way, how each firm's loss, revenue, and capital ratio would likely respond in any specified scenario," said Bernanke.