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Fed Creating More “Stress Test” Scenarios To Look For Vulnerabilities In Banks

Social Security Benfits
Social Security Benefits; Source- CNET

Michael Barr, the Vice Chair of the Federal Reserve Board’s Supervision Committee, spoke during a House Financial Services Committee hearing regarding the response to Silicon Valley Bank’s previous bank failures.

Flaws In Big Banks

As part of its stress test for 2024, the U.S. Federal Reserve is creating more scenarios to look for flaws in big banks, a top regulatory official announced on Thursday.

Vice Chair of the Fed for Supervision The extra scenarios, according to Michael Barr, would be “exploratory” and would not aid in determining a firm’s capital requirements. They would look at different kinds of hypothetical economic and market stress. However, he continued, a wider range of pressures might make it easier to spot fundamental flaws and enhance how regulators oversee big businesses.

Barr had previously said he was looking into using several scenarios to broaden the scope of the yearly examination of the health of large banks, but this speech on Thursday is the first official indication that they will be included in the exam in 2024.

Increase In Unemployment

The Fed currently examines the performance of large banks during a fictitious severe recession, which usually entails a dramatic increase in unemployment and a decrease in economic growth. The amount of excess capital each bank must retain to protect itself against losses is known as the “stress capital buffer,” and it is determined by the magnitude of losses banks would experience in that scenario.


Source- CNET

Barr noted that the additional “exploratory” scenarios would not contribute to the buffer’s establishment, but he contended that a more diversified test would enable the Fed to examine a wider range of potential vulnerabilities and may aid Fed supervisors in better policing banks.

Barr also cautioned against banks reducing their investment in their own risk management or fine-tuning their portfolios to optimise test results if they just used one scenario.

Although Barr did not outline the specific topics the scenarios will look at, he did state that he did not think many scenarios would be required to represent “a wide range of outcomes for the banking system.”

If the Fed were to ever change the model it employs to determine bank capital, he further stated that it would do so via a “transparent, public process.”

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