Fed Plans to Give Wall Street More Help on Bank Stress Tests

(Bloomberg) -- The Federal Reserve plans to provide more information on how its stress tests will trigger losses for bank loan portfolios, a move that should give lenders an advance look at how they might fare in the annual exams that have huge implications for how they run their businesses.

Banks have repeatedly complained that the tests, which determine whether firms can pay dividends to investors, are too opaque. The Fed is trying to address those concerns and will begin disclosing “much more granular” information in the coming months on how the scenarios in its exams will affect a range of different loans, Governor Jerome Powell said.

“We're committed to running as transparent as possible and as effective as possible a set of stress tests,” Powell said Thursday an interview with CNBC. “We do hear these complaints.”

The stress tests -- put in place after the 2008 financial crisis to ensure banks can survive another economic meltdown -- are one of the industry's most stringent regulatory demands. Lenders need a high-level of capital to get a passing grade and the consequences for failing are severe, with firms facing restrictions on paying profits to investors, limits on buying back shares and damage to their reputations.

Easing Constraints

Powell's comments show regulators are trying to ease constraints on Wall Street -- a top goal of President Donald Trump -- even without congressional intervention. Powell said the Fed is also working to make the Volcker Rule less burdensome. The provision, included in the 2010 Dodd-Frank Act, restricts banks from making speculative market bets with their own capital.

For its stress tests, the Fed announces hypothetical scenarios each year such as severe recessions that the largest banks must be tested against. The 2018 exams will feature a sample portfolio to show banks how certain assets would be affected by the invented crisis, Powell said. It's not total transparency, but seeing the extent of losses those holdings might experience would give banks a better picture of what to expect, without throwing back the curtain completely.

Wall Street bankers have long argued that they can't accurately evaluate how the Fed's scenarios will impact capital levels if they don't know the nuts and bolts of the agency's models. However, in recent years, regulators have begun to provide more substantial responses in their annual feedback. The Fed has also held frequent discussions with lenders.

The subjective nature of the exercises is the main concern of Wells Fargo & Co. Chief Executive Officer Tim Sloan, he said in a May 24 interview with Bloomberg Television. Making it more objective would let his company set its strategy “without being concerned about future changes in regulation.” It could also return more capital to shareholders, he said.

For the 2017 stress tests, the Fed announced Thursday that it will release the results that Wall Street pays the most attention to on June 28. In its disclosures, the Fed will give banks more information about how they were evaluated on the hard-to-plan-for “qualitative” aspect of the exams that weighs a lender's plans for managing capital and risk, Powell said.

Bank Boards

Powell is the governor in charge of banking regulations, having replaced predecessor Daniel Tarullo in that role. Tarullo left in April after the Trump administration took power, though the president hasn't yet named a vice chairman of supervision who will ultimately be responsible for the Fed's stress tests.

Powell's greater sympathy for the industry's regulatory burdens was apparent in another adjustment he said the Fed is making: a “reset” of the expectations for bank boards. He said the Fed is working to clarify that boards are meant to be responsible for oversight of their firms, not day-to-day compliance with regulators' demands, he said.

“We're going to eliminate many of the really specific directives that we give to boards of directors,” he said. “We want directors to focus on their man job of overseeing and holding accountable the management, not running the company.”

--With assistance from Dakin Campbell

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net.

To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net, Gregory Mott