Fed PolicyMortgage

Fed looks to eliminate pass/fail for bank stress tests

To take volatility out of financial markets

The Federal Reserve is looking to take volatility out of the financial markets by changing the rules of stress tests on big banks, and eliminating the pass or fail grades.

The Fed would replace the pass or fail grade with simply giving banks a capital ratio that the lender must meet during the following year, according to an article by Ryan Tracy for The Wall Street Journal.

This year, the 35 largest banks in the U.S. passed the first round of the Fed’s annual stress test, but during the second round of stress tests, one bank could still fail the exam.

From the article:

The changes, set in motion during the Obama administration and continuing under President Donald Trump, reflect the Fed’s uneasiness with surprising bankers and financial markets with bad news, such as Citigroup Inc.’s unexpected stress-test failure in 2014.

The modifications also demonstrate how Fed officials have grown more comfortable with big banks’ risk-management chops after the 2008 financial crisis exposed significant weaknesses. Last year, no banks failed, the first time that happened since the Fed began disclosing annual results in 2012.

The upcoming changes could mean banks save millions of dollars in compliance costs as there will be less urgency to invest in passing the tests.

In the model the Fed is now considering, a bank’s performance on the stress test would not result in a pass or fail, but rather would determine the bank’s capital requirements for the following year. In order to comply with the requirements, banks would have to limit shareholder payouts.

Essentially, the results would remain the same, but there would be less public rebuke, the article states.

The Fed hopes to implement its new changes for the 2019 exams and is currently reviewing public comments on the changes.

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