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July 18, 2018

Ms Beverly Hirtle of the Federal Reserve Bank of New York spoke at the conference on "The Effects of Post-Crisis Banking Reforms" in New York City. She discussed the current supervisory stress testing regime and assessed whether it continues to address the macro-prudential objectives. For this discussion, she used the six elements that she and her co-authors argued, in a paper, made the Supervisory Capital Assessment Program (SCAP) a successful macro-prudential exercise. These six elements are comprehensiveness; consistency; multiple, independent estimates; diverse perspectives; transparency of process and results; and clear and predictable goals and actions.

Referring to the recent passage of the Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCP Act), she said that many banks will no longer be subject to DFAST supervisory stress testing or could participate only on a periodic basis. Whether the set of banks that continue to be subject to the annual DFAST supervisory stress testing represents a large enough share of the overall banking industry and sufficiently spans the range of banking activities to provide a comprehensive perspective is something that merits monitoring and analysis, said Ms. Hirtle. She also mentioned that their paper argued that the financial crisis environment gave the SCAP a very clear goal of providing confidence that the banking system could continue to lend even under more dire economic conditions, as a way of mitigating the chance that those dire economic conditions actually materialized. In that sense, the SCAP was very much a "lean into the wind" macro-prudential exercise.

However, in the current environment, she would argue that the goals of the supervisory stress testing regime are more diffuse. There are clearly micro-prudential "safety and soundness" objectives related to sound capital planning, risk identification, and capital adequacy at each of the firms participating in the exercise.  These are critically important objectives. According to her: “What is less clear to me is what role cyclical macro-prudential concerns play in the evolving stress testing regime. Clearly, the design of the stress test scenarios, which embed a number of counter-cyclical features, is an important channel for "lean against the wind" or "lean into the wind" efforts. However, narrowing the set of firms subject to DFAST supervisory stress testing potentially pushes away from the broader cyclical perspective. Less of the banking industry will be covered by the stress tests and assessments of the strength of the industry will be based on a smaller part of the whole.“

She believes that ensuring that the largest and most systemically important banks do robust capital and liquidity planning, have strong internal controls, do good risk identification, and have very healthy amounts of capital (especially common equity) and liquidity resources is fundamental to fostering a stable banking system that can perform its critical financial intermediation role in both calm and stressed economic environments. “What I hoped to do today is simply to point out that one of the key objectives of the original SCAP stress program—leaning into the wind during a severe economic downturn—might be getting less emphasis as the time since the financial crisis grows, the economic expansion continues, and the supervisory stress testing regime evolves,” said Ms. Hirtle.


Related Link: Speech

Keywords: Americas, US, Banking, Stress Testing, DFAST, EGRRCP Act, SCAP, BIS

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