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GAO Report Pans Fed’s Stress Test Programs for Banking Institutions

gao_government-accountability-office_logoA recent study by the GAO reviewing the effectiveness of the Fed’s stress test programs for financial institutions indicated that the programs’ limitations could hamper their effectiveness in determining whether institutions have sufficient capital to remain solvent under difficult economic conditions.

In the report, the GAO identified several means of improving the programs’ efficacy. Recommendations include the Fed, FDIC and OCC “harmonizing” their agencies’ approaches to granting extensions and exemptions from stress test requirements to ensure that institutions overseen by different regulators receive consistent regulatory treatment.

The GAO recommends that the Fed provide increased transparency and improved testing effectiveness by publicly disclosing additional information that would help financial institutions better understand “the methodology for completing qualitative assessments, such as the role of ratings and rankings and the extent to which they affect final determination decisions,” according to the report. The report also noted that if the Fed objects to an FI’s capital plan, it should provide greater information for why it did so.

The Dodd-Frank Act instituted stress test requirements, known as the Dodd-Frank Act Stress Tests (DFAST) for Fed-supervised banking institutions with more than $10 billion in total consolidated assets, and they project how financial institutions’ capital levels would fare in hypothetical stressful economic and financial scenarios. The Fed also conducts a Comprehensive Capital Analysis and Review (CCAR) to make supervisory assessments and decisions about the capital adequacy plans of large bank holding companies with total consolidated assets of $50 billion or more.

hensarling_jebRep. Jeb Hensarling (R-Texas), who is chairman of the House Financial Services Committee, requested the report in September 2014 to determine the benefits, effectiveness, costs and transparency of the Fed’s stress tests.

“The Dodd-Frank Act vastly increased the powers of the Fed way beyond its traditional monetary policy responsibilities,” Hensarling said in a statement following the GAO report’s release. “The GAO report confirms the secrecy surrounding the stress tests makes it almost impossible to measure the effectiveness of the Fed’s regulatory oversight or the integrity of the tests’ findings. Not only are [the stress tests] not transparent, they are often duplicative and impose unnecessary costs and burdens on financial institutions that are ultimately passed on to consumers.”

Although the Fed “generally agreed” with the recommendations, according to the GAO report, Fed Gov. Daniel K. Tarullo, while facing complaints concerning a lack of transparency in the models the Fed uses to measure bank capital levels, said on Sept. 26 that he would not give big banks more details about how examiners evaluate capital levels. Banks involved in the DFAST and the CCAR have frequently requested more disclosures so that they can better understand the likely impact on their organizations.

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