Dj Banks Sue Fed Over Stress Testing

Abby Schultz

Organizations representing the nation's largest banks and business groups sued the U.S. Federal Reserve on Tuesday for stress-test practices they say are opaque and lead to inaccurate capital charges.

The suit was filed a day after the Fed said it would seek public comment beginning early next year on the agency's plans to improve transparency in the annual stress-test process.

The lawsuit was filed in the U.S. District Court for the Southern District of Ohio Eastern Division by the Bank Policy Institute, the Ohio Chamber of Commerce, the Ohio Bankers League, the American Bankers Association, and the Chamber of Commerce.

In a Monday news release, the Federal Reserve said the board was seeking comment on changes that would "improve transparency of bank-stress tests, and reduce volatility of resulting capital requirements."

The proposed changes include seeking public comment on models that determine hypothetical losses and revenue of banks during stressful periods, in addition to allowing the public to comment on the scenarios the board uses before they are finalized, the Fed said in its release.

Next year, the Fed will "take immediate steps to reduce the volatility of the results and begin to improve model transparency," it said.

In a statement, the plaintiffs noted the Fed's acknowledgment of a problem, but they sued anyway to preserve their right to challenge the board's approach. That's because the statute of limitations on agency actions establishing the stress-test framework expire in February 2025.

"Filing comments on potential changes is great, but it doesn't change anything yet," Steve Stivers, president and CEO of the Ohio Chamber of Commerce told Barron's.

The stress tests were designed to ensure banks have enough capital to survive an economic downturn and were first instituted by the Fed after the financial crisis. The banking and business organizations filing the lawsuit agree stress tests are valuable, but "we just want them to be accurate," Stivers said.

According to the lawsuit, the Fed's lack of transparency into the models and scenarios they use each year for stress testing is illegal and ultimately harms businesses and consumers.

"We've talked to a lot of member banks, and we've talked to main street businesses that tell us they don't have as many opportunities as they think they could or should have to get credit," Stivers said.

The lawsuit could have been filed in any state, he added. Ohio is home to several regional banks — including KeyCorp, Fifth Third Bancorp, and Huntington Bancshares — all of which serve consumers in addition to middle-market and large businesses.

"For years, we have highlighted serious concerns about the stress testing framework and the need for reform," Greg Baer, the Bank Policy Institute's president and CEO, said in a statement on Tuesday. "The current opaque regime, combined with the lack of clear standards for the global market shock and the operational risk charge, continues to produce capital charges that are inaccurate, volatile and excessive, resulting in reduced lending and economic growth."

The institute, which represents major banking organizations including Bank of America, Citigroup, Goldman Sachs Group, and JPMorgan Chase, among others — and the co-plaintiffs — argue that secrecy surrounding the current stress-testing framework violates the Constitution and federal statutes such as the Administrative Procedure Act, according to a statement.

The APA requires public notice and a comment period for any significant regulatory changes, the statement said. But the Federal Reserve often "substantially" changes the minimum amount of capital a bank must hold without doing so, the statement said. "Subjecting the work and thinking behind these capital charges to public scrutiny would allow errors, mistakes and poor policy choices to be clearly illuminated, and thus corrected," the statement said.

According to the plaintiffs, "arbitrary, counterintuitive, and sometimes inaccurate results," occur each year. "The lack of transparency and volatility in the results makes it difficult for banks to plan and manage capital effectively, leading to higher borrowing costs for their customers," they said.

A Federal Reserve spokesman didn't immediately have a comment on the lawsuit.

Write to Abby Schultz at abby.schultz@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

Certain US bank and business groups said Tuesday that they filed a lawsuit against the Federal Reserve over what they termed as a "flawed" stress-testing framework.

The lawsuit was filed by the Bank Policy Institute, the American Bankers Association, the US Chamber of Commerce, the Ohio Bankers League, and the Ohio Chamber of Commerce. The Bank Policy Institute represents major banks such as JPMorgan Chase , Citigroup and Goldman Sachs .

"While stress testing is an important risk management tool for banks and supervisors that helps ensure that banks have sufficient capital to withstand severe economic shock, the lawsuit seeks to resolve longstanding legal violations by subjecting the stress test process to public input as required by federal law," the plaintiffs said in a statement. "Without the legally required transparency that applies to other federal regulations, the stress tests amount to an illegal intervention into the cost of capital, with detrimental results for the economy."

The lawsuit alleged, among other things, that the lack of transparency in stress test results, along with volatility, makes it tough for banks to manage capital effectively, raising borrowing costs for customers.

The Fed declined MT Newswires' request for comment on the matter.

On Monday, the Fed said it intends to take "immediate" measures to reduce volatility of 2025 stress test results and improve transparency. It plans to start a public comment process on its proposed changes during early next year. The proposed changes don't aim to "materially affect" banks' overall capital requirements, the Fed said in a statement at the time.

The Bank Policy Institute and its co-plaintiffs said Tuesday that their lawsuit preserves "legal options" going forward.

"We appreciate the (Fed's) announcement as a first step towards transparency and accountability, but believe it is necessary to file this suit to preserve our legal rights," Bank Policy Institute Chief Executive Greg Baer said.

Michael Adelman, CEO of the Ohio Bankers League, said that "we are advocating for a fairer, more transparent framework," while Tom Quaadman, senior vice president of economic policy for the US Chamber of Commerce said the current stress test regime "restricts business financing."