Federal Reserve Implements Changes to Bank Stress-Testing Rules

One rule mandates that the Fed board must solicit public comments on annual stress test scenarios and any significant alterations to related models. Under this rule, banks will be assessed against two global market shock components each year, with stress-test results determined by the shock causing the greater loss.

The second rule requires the Fed to compute a bank's stress capital buffer by averaging the results of the last two annual tests. This rule is scheduled to take effect in 2028.

In addition to these rules, the Fed also requested public feedback on a revision to the model it uses to measure noninterest income. Comments on this proposal, which aims to better reflect how banks generate fee income, must be submitted within 60 days after publication in the Federal Register.

The changes are expected to significantly reduce annual volatility in capital requirements tied to stress tests, possibly by as much as 50%. Michelle Bowman, the Fed’s vice chair for supervision, stated that the revisions enhance the resilience of the stress test framework by ensuring it remains transparent and sensitive to risks. She emphasized that the new approach will provide the public with increased confidence that the risks banks undertake will be accurately represented in their stress test losses and capital requirements.

The Fed's board voted 6-1 to finalize the first rule, with dissent from Michael Barr, Bowman's predecessor, who expressed concerns that the changes might decrease the dynamism and reliability of stress tests, potentially undermining financial stability.

The updates have been anticipated since they closely resemble initial proposals from the previous October, with Bowman discussing them earlier this month in a speech in London.

In December 2024, the Fed faced a lawsuit from trade organizations, including the American Bankers Association (ABA) and the Bank Policy Institute (BPI), regarding its efforts to improve stress-test transparency and reduce capital requirement volatility. These groups praised the Fed's proposal as a positive example of public engagement, stating that transparency would enhance the stress-testing framework and improve capital planning at covered banks, benefiting the economy.

Conversely, the advocacy group Better Markets criticized the changes as rendering the stress-test process increasingly ineffective and disconnected from real banking risks. Christopher Appel, the group’s director of banking policy, suggested that the modifications could encourage banks to game the models rather than focus on underlying risks. Better Markets has also filed a lawsuit against the Fed, claiming Bowman held undisclosed meetings with bank executives regarding public comments on capital requirements.

The revised stress-testing framework is set to take effect on December 31. The Fed plans to open stress test scenarios for public comment beginning January 10 and aims to finalize them by February 28.