The effectiveness of the U.S. Federal Reserve’s stress tests for the largest U.S. bank holding companies is limited by, among other things, a lack of transparency, according to a government watchdog.
The Government Accountability Office said in a report released Tuesday that the Fed has not disclosed information needed to fully understand how it assesses whether banks would maintain sufficient capital in a future crisis or why it decided to object to a bank’s capital plan.
“Transparency is a key feature of accountability and such incomplete disclosure may limit understanding of the [capital plan] assessments and hinder public and market confidence in the program and the extent to which the Federal Reserve can be held accountable for its decisions,” the GAO warned.
The capital plan tests are officially known as the Comprehensive Capital Analysis and Review (CCAR). The GAO faulted the Fed for failing to regularly update guidance to banks about supervisory expectations and peer practices related to the qualitative assessment.
“The limited communication can pose challenges to companies that must meet these expectations annually and could hinder the achievement of CCAR goals,” it said.
The stress tests were mandated under the post-financial crisis Dodd-Frank law and the Fed has so far conducted six rounds of testing. The GAO report was requested by House Financial Services Committee Chairman Jeb Hensarling (R-Texas), a reported candidate to be Secretary of the Treasury in the Trump administration.
“When it comes to the Fed’s stress tests, not only are they not transparent, they are often duplicative and impose unnecessary costs and burdens on financial institutions that are ultimately passed on to consumers,” he said Tuesday.
The GAO also found limitations in the design of stress-test scenarios and the Fed’s management of the risk of negative consequences from decisions based on incorrect or misused test results.
Among the reports’ recommendations is that the Fed disclose “additional information that would allow for a better understanding of the methodology for completing qualitative assessments, such as the role of ratings and rankings and the extent to which they affect final determination decisions.”