WASHINGTON — The Federal Reserve Board is working on next steps in reforming its stress testing program, including providing a more helpful guide on how the central bank’s testing models work and taking a lighter touch to supervising bank boards, according to a top official.
Delivering his first remarks on bank regulation since taking over as chair of the Fed’s supervisory committee in April, Fed Gov. Jerome Powell told CNBC that the agency is committed to taking a fresh look at the post-crisis regulatory framework and assessing what can be improved.
“I would say the post-crisis reform program has been mostly completed and has mostly been successful,” Powell said. “It’s our obligation now, as we reach completion, to look back over it and ask what aspects of it may be redundant, or inefficient, or utterly essential and should be protected down to every letter. But there are going to be some adjustments, and I think that’s only appropriate. A lot of this stuff was novel, and it would be very surprising if we got it all exactly right the first time.”
Powell specifically said the agency is working out a better way to communicate its capital expectations to regulated banks, particularly as they pertain to the annual stress tests. In response to complaints that the stress testing models are too opaque, he said that in the coming months the Fed will devise a process that will help banks better understand how different assets perform under the Fed’s stress testing models.
“We do hear these complaints, and we are working, as we have been continually, to provide more information, more transparency,” Powell said. “We’re working on something that we’ll do in the coming months which will provide much more granular information for our expectations for loss rates on particular portfolios, corporate loans and other kinds of things. That will help.”
The Federal Reserve’s stress testing program is widely regarded — both by its critics and supporters — as among the most consequential innovations to emerge from the Great Recession. There are two separate stress tests that the Fed performs: the Dodd-Frank Act Stress Test and the Comprehensive Capital Assessment and Review. The tests differ in some ways, but both take a bank’s balance sheet and run it through nine consecutive future quarters of hypothetical stress scenarios to see how a bank’s capital levels perform.
Those models that the Fed relies upon to conduct its stress tests, particularly CCAR, are not perfectly understood by the banking industry. Fed officials argue that divulging too much information about the models would make the process a rote exercise and nullify any prudential benefits that stress testing confers.
Others have argued that the opacity of the stress test scenarios makes it impossible to know how to allocate capital in the most effective way. Industry groups have even floated the idea that the opaque nature of the stress testing models and the process for generating the hypothetical stress scenarios may violate the Administrative Procedure Act by creating binding regulatory burdens about which affected banks are not given advance notice and comment. Members of Congress have also targeted the CCAR program as a part of the overall push to ease banking regulation.
The Fed, for its part, has been open to improving the stress testing program. Former Fed Gov. Daniel Tarullo, who headed the Fed’s supervisory committee for years before his retirement in April, laid out a blueprint for how to make the stress testing program more nimble and considerate of each individual firm’s capital allocations. And the agency in January finalized changes to the CCAR program that would greatly reduce the number of banks that will be subject to qualitative stress testing requirements.
Powell's comments suggest that the Fed will continue its efforts to revise its stress testing program even in the absence of any input from a vice chair of supervision, a position created by Dodd-Frank that would be the top regulatory authority at the Fed beside the chair. The position has never been filled, though Tarullo was acting as a de facto vice chairman of supervision throughout his tenure, and President Trump has yet to name any nominees to the Fed despite three open seats.
The stress test revisions are not limited to the board’s new guidance on the models, Powell said. Soon after the agency’s initial stress testing results are published on June 22 — a date that had previously not been disclosed — the Fed will issue some additional guidance “on how we think about the qualitative requirement.” Powell said the Fed will also “seek comment from the public on how we go about providing more transparency” to the stress testing program beyond these initial steps.
Powell touched on other reforms as well. He said that the Fed is working on “a less burdensome way to implement” the Volcker Rule, though the agency is constrained to some degree by the dictates of the Dodd-Frank law. He also said the agency is looking to reduce its supervisory requirements for bank boards of directors, freeing them from direct responsibility for individual initiatives at the bank and instead focusing on management.
“We’re working on a reset, really, of how our supervision interacts with boards of directors,” he said. “We’re going to move to a more principles-based approach and we’re going to eliminate many of the really specific directives we give boards of directors. The idea being, we want directors to focus on their main job of overseeing and holding accountable the management and running a company, and not getting tied up in a little checklist. They’re being freed up to think about the strategy of the company and the performance of management.”