Big Banks Sue the Fed Over Lack of Transparency in Annual Stress Test

The Bank Policy Institute (“BPI”), consisting of major banks like JPMorgan (JPM Quick QuoteJPM – Free Report) , Citigroup, Inc. (C Quick QuoteC – Free Report) , and The Goldman Sachs Group, Inc. (GS Quick QuoteGS – Free Report) , has filed a lawsuit against the Federal Reserve over the annual stress testing framework and its transparency.
 
These major banks have joined the American Bankers Association, the Ohio Bankers League, the Ohio Chamber of Commerce and the U.S. Chamber of Commerce to file a combined lawsuit.

Details of the Lawsuit

The Fed’s stress test is an annual examination to assess the impact of a series of catastrophic economic scenarios on big banks such as JPM, C and GS. The results are used for the calculation of overall capital buffer requirements to provide a cushion against such losses. It further dictates the size of share repurchases and dividends.

The lawsuit claims that the Fed’s stress test procedure doesn’t follow adequate administrative procedure.

Specifically, the plaintiff parties want the Fed to publish its stress test models and scenarios and allow public comments and notifications on future models.

In the lawsuit, the banking groups stated that they don’t oppose annual stress. However, the existing process falls short and “produces vacillating and unexplained requirements and restrictions on bank capital.”

Further, the banks complained that uncertainties surrounding the test results and future regulations make it difficult for banks to plan and manage capital effectively, leading to higher borrowing costs for customers. Also, these weaken banks’ market-making and capital markets capabilities, essential for economic growth.

Are the Proposed Fed Changes Enough?

On Monday, the Fed announced that it is considering proposing changes to the stress tests and will be seeking public comment on what it calls “significant changes to improve the transparency of its bank stress tests and to reduce the volatility of resulting capital buffer requirements.”

The central bank, determined to modify the tests amid an evolving legal landscape, aims to reduce the volatility of the results and improve model transparency. The public comment process on stress test is likely to begin in early 2025.

Though JPM, C, GS and other major banks will likely perceive the changes as a win, the alterations may not go far enough to address the banks’ concerns regarding strenuous capital requirements. The Fed stated, “These proposed changes are not designed to materially affect overall capital requirements.”