New Fed regulatory chief eyes shift in US bank stress tests

New Fed regulatory chief eyes shift in US bank stress tests

The top financial regulator appointed by President Donald Trump has initiated a set of bank-friendly changes with his first major policy move by proposing to bring new transparency to stress tests loathed on Wall Street.

Randal Quarles, who was confirmed as the Federal Reserve’s head of supervision in October, announced a series of proposals on Thursday to reduce the opacity of its stress testing programme, which banks have long criticised as a “black box”.

The move by Mr Quarles marks the most significant step towards deregulation yet by the Trump-era Fed. During the 2016 campaign Mr Trump vowed to “dismantle” Dodd-Frank, but he and his appointees have not yet undone any significant regulations.

Stress testing is a foundation of the new regulatory framework put in place after the last financial crisis by the Dodd-Frank act, which Republicans and banks blame for stifling lending and economic activity.

The proposals, which the Fed said were developed “in response to feedback”, would release more information to banks — and the public — about the models the Fed uses to estimate the losses banks would sustain in a severe financial crisis.

Stress test results are one of several key indicators that determine how much capital regulators require banks to hold and they have in recent years forced some lenders to scale back their plans to return capital to shareholders.

Since 2011, the two-part test — often identified by the name of its second part, the Comprehensive Capital Analysis and Review — has also prompted banks to spend billions of dollars on improving the way they track risks.

Senior executives have long complained that the Fed has kept its cards too close to its chest, refusing to share details about its assumptions, and thus forcing the banks to err on the side of caution when making requests to hand back capital.

Similar proposals had been floated earlier this year by Mr Quarles’ predecessor, Daniel Tarullo, an Obama appointee normally seen as an enemy of Wall Street, then endorsed by Jay Powell, who Mr Trump has nominated as the next Fed chair.

They were approved by current chair Janet Yellen, Mr Powell, and Lael Brainard, who along with Mr Quarles make up the Fed board.

Mr Quarles, vice-chairman for supervision, said: “This enhanced transparency will bolster the credibility of our stress tests and help the public better evaluate the results. The proposed changes will also generate valuable insight from stakeholders and we look forward to it.”

Banks have also grumbled about the way the Fed keeps shifting the goalposts and the excruciatingly public release of stress test results in which the Fed announces whether banks have passed, failed or fallen somewhere in between that requires remedial action.

Mr Quarles was previously a private equity executive and official in the George W Bush administration.

The Fed said specifically that it would publish more details on key equations in its models, the range of loss rate estimates it uses, and the portfolios of hypothetical loans in its models.

Defenders of the current regime argue that providing more information to banks will encourage them to game the system, setting up their businesses to pass the tests even if their underlying strength is far lower than regulators would like.

The Fed is seeking comment on its proposals by January 22, 2018. The next stress test cycle is due to begin in February when the Fed will give banks its crisis scenarios and instructions for them to comply.

The Fed did not say when any changes to the stress test regime would become effective if they were made.

Mr Tarullo suggested publishing hypothetical loan portfolios but warned against publishing entire models, saying doing so could “result in less protection for the financial system”.

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