Opacity vs. Transparency at the Federal Reserve Stress Testing Conference

Michelle Lucci, CRCM, CAMS
July 19, 2019
Read Time: min

Last week, the Federal Reserve hosted a stress testing conference in Boston, MA.  The conference brought together regulators, bankers, economists, and others to discuss the most important annual check on the stability of the banking system.

The initial stress test conducted in 2009 was described as a “wartime” test meant to reassure the public that the system was solvent, and it was very effective. A decade later, the economy is far less dire, which was reflected in this year’s ninth annual test, a “peacetime” test. The participating institutions all passed, although JP Morgan Chase and Capital One struggled and had to adjust their capital plans to meet minimum thresholds. This success paves the way for increased capital distributions. Although most bankers and regulators will find the results to be good news for the industry, conference attendees’ sentiment towards future tests were divided. Some attendees favored increased transparency of the models and scenarios, including the Fed Chairman and Vice Chairman, while others preferred continued maintenance of some level of opacity. The two perspectives made for spirited discussions that volleyed between the benefits of each angle.

Proponents of transparency are already making strides. Earlier this year, the Fed published their first Stress Testing Policy statement, an eighty-page document containing specific details of two key models along with loss rates, and plans to release similar information every year going forward. The Fed is also contemplating issuing specific details on the scenarios and scenario design.

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In his keynote address, Vice Chairman Quarles noted that Congress raised the threshold for participating banks to those with $100 billion in assets. This change was in response to the Fed’s finding that the test was found to be “less effective” in small firms. However, there was no further detail given to support a very significant rollback in bank regulatory framework. If a bank failed just under the new $100 billion threshold, it would represent the most significant failure in history, except for Washington Mutual (which failed in 2008 with total assets of $307 billion). Before Washington Mutual’s failure, the largest bank failure was in the range of $40 billion in total assets.

There are certainly valid points when discussing transparency and regulatory rollbacks; however, we must not solely discuss each point individually. The larger picture and the possible consequences of all rollbacks must be taken into account. As one panelist noted during the conference, “when it comes to financial regulation, it’s always wartime.” The economy is currently in the late stage of the longest economic expansion on record, and bankers are happy in an industry that is doing very well. While it can feel natural to want to loosen the reins, signs of deterioration have emerged, and prudent regulation will continue to be important to avert another crisis.

About the Author

Michelle Lucci, CRCM, CAMS

As a Senior Advisor for MST Advisory Services, Michelle Lucci, CRCM, CAMS, brings her clients more than 30 years’ experience in banking, regulation and third-party services. Michelle focuses on two areas within the company - the ALLL and CECL as well as loan portfolio stress testing. Prior to joining Abrigo, Michelle served numerous roles in financial services, including as a dual-commissioned FDIC bank examiner for both Risk Management and Consumer Compliance in the New York and Atlanta regions. She was also both a financial and regulatory analyst at Citigroup and a BSA, OFAC, and community reinvestment officer at CenterState Bank of Florida. As a senior advisor for Abrigo’s Advisory Services, Michelle guides our clients through the transition and implementation processes of CECL programs, loan portfolio stress testing solutions, and BAM+. Michelle earned her bachelor’s degree in business administration from Georgian Court University.

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