Bank Lobbyists Sue Fed Over Stress Test Transparency

In a move that could reshape the banking landscape, prominent banking and business groups have filed a lawsuit against the Federal Reserve, alleging a lack of transparency in the annual stress tests that determine capital requirements for banks. The suit, filed by the Bank Policy Institute (BPI), American Bankers Association (ABA), and other trade groups, seeks to challenge the Fed's stress test models and scenarios, claiming they are developed in secret and result in volatile capital requirements that impact the cost of financial services in the US.

The stress tests, imposed after the Great Financial Crisis, aim to gauge how banks would fare during a hypothetical recession. However, the opacity of the Fed's stress test process has drawn criticism from bank lobbyists, who argue that the lack of transparency hinders their ability to lend to small businesses and consumers. The lawsuit contends that the Fed's criteria for the tests are designed in secret, leading to "vacillating and unexplained requirements and restrictions on bank capital."

The lawsuit asks the court to declare unlawful the models and scenarios used in the 2024 stress test, as well as those in the 2025 and 2026 versions. The groups also want the Fed to allow for public comments on the models beforehand. A Fed spokesperson declined to comment on the lawsuit.

The central bank has acknowledged the concerns raised by the banking industry and announced plans to overhaul its stress tests. The Fed intends to disclose and seek public comment on all models that determine hypothetical losses and revenue of banks under stress. Additionally, the Fed will average results over two years to reduce year-over-year changes in capital requirements and ensure that the public can comment on hypothetical scenarios before they are finalized.

The lawsuit comes as the Fed braces for potential impacts of an evolving legal landscape and changes in the framework of administrative law. US agencies, including the Fed, are facing pressure from the incoming Trump administration and bankers to regulate with a lighter touch. Earlier this year, the US Supreme Court curtailed the power of regulators to interpret laws.

The Fed's proposed changes to the stress test process aim to address the concerns raised by the banking industry while maintaining the integrity of the tests. By enhancing transparency and inviting public comment, the Fed seeks to improve the resiliency of the stress tests and reduce the volatility of resulting capital buffer requirements.

As the lawsuit progresses, the banking industry and the Fed will continue to engage in dialogue, seeking a balance between transparency and the safety and soundness of the banking system. The outcome of this legal challenge could have significant implications for the banking sector, investors, and the broader economy.