A decade after the entire financial system nearly collapsed in 2008, Fed officials are moving to relax the annual procedure, in which banks are graded on their ability to withstand a severe financial crisis. Those banks that failed the test have had to limit shareholder payouts in the form of dividends and stock buybacks -- and instead retain the capital as a bulwark against loan defaults or trading losses.
The new push to relax the tests is being led by Randal Quarles, a former financial-industry lawyer and private-equity executive who was appointed last year by President Donald Trump as the Fed's vice chairman for supervision, putting him in charge of overseeing the biggest banks. Trump and officials in his administration have pledged to loosen regulations in the banking industry and other sectors, arguing that the steps will promote faster economic growth.
in the wake of the 2008 crisis, U.S. officials instituted the annual stress tests, known formally as the "Comprehensive Capital Analysis and Review." The tests have been used by the Federal Reserve to pressure banks to increase their levels of capital -- the buffer of extra assets that firms must keep on hand to absorb steep losses -- and avert the need for taxpayer-funded bailouts.
"As firms become more resilient, they may no longer need to build capital to support their current level of risk taking," Quarles said Friday, Nov. 9, in a speech in Washington at the Brookings Institution. Former Fed Chairs Ben Bernanke and Janet Yellen serve as fellows at the nonprofit public-policy organization.
Among the changes proposed by Quarles in his speech: Banks will no longer fail the annual stress test for tripping a "supplementary leverage ratio" -- a simple test that serves as the most basic gauge of a bank's borrowing level. Under that test, banks can't borrow more than 97% of the value of their assets.
Earlier this year, Goldman Sachs and Morgan Stanley (MS) both received "conditional" passing grades on the annual procedure because they failed this leverage test.
According to Quarles, banks that trip the test in future years would avoid such public failures and instead be quietly urged, in secret, closed-door supervisory discussions with bank executives, to reduce their risk, Quarles said.
Another change could allow banks to be more aggressive in their annual requests for approval for dividends and stock buybacks.
In the past, banks had to submit these capital-distribution requests in tandem with the stress-test procedure. Since bank executives didn't have the advance test results, they had to be more conservative in the distribution requests -- to make sure that the distributions alone wouldn't cause them to fall below required regulatory thresholds.
"If it guesses wrong, it could be publicly shamed for failing the stress test," Quarles said.
Instead, banks should be entitled to receive the results before submitting the dividend and stock-buyback requests, the official said. Under that change, it could be far easier for banks to avoid failing.
"Firms have told us that they would be able to engage in more thoughtful capital planning if they had knowledge of that year's stress test results before finalizing their distribution plans for the upcoming year," Quarles said. "I am sympathetic to their concerns."