The Bank Policy Institute (BPI), along with other prominent business and banking organizations, has initiated legal action against the Federal Reserve, alleging violations of federal law concerning the transparency and regulatory process of the annual bank stress tests. The lawsuit contends that the Federal Reserve’s stress testing framework lacks sufficient transparency, hindering accurate capital planning, and ultimately impacting lending and economic growth. The plaintiffs argue that the opaque nature of the tests, particularly concerning the models and scenarios employed, along with the absence of clear standards for global market shocks and operational risk, results in volatile and excessive capital requirements. This, they claim, impacts businesses by increasing borrowing costs and reducing access to credit, stifling economic activity.
The stress tests, implemented after the 2008 financial crisis, are designed to assess the resilience of banks to potential economic downturns and ensure they hold adequate capital to withstand adverse conditions. However, the lawsuit argues that the Federal Reserve’s implementation violates the Administrative Procedure Act, which mandates public notice and comment periods for significant regulatory changes. The plaintiffs allege that the Federal Reserve annually adjusts minimum capital requirements without adhering to these legal requirements, effectively making crucial regulatory decisions without affording the public an opportunity to contribute. This lack of transparency, they argue, not only violates established legal procedures but also prevents meaningful insights into the validity and impact of the stress test methodologies.
The core of the plaintiffs’ argument revolves around the need for greater transparency and public participation in the stress testing process. While acknowledging the importance of stress testing as a risk management tool, the lawsuit emphasizes that the current opaque framework undermines its effectiveness. The plaintiffs seek a fairer, more predictable regulatory environment, arguing that publishing the supervisory models and stress scenarios, and inviting public comment, would enable banks and the public to better understand and prepare for regulatory expectations. This transparency, they believe, would promote a more robust and accountable system, ensuring that stress tests effectively assess risk without unnecessarily restricting lending and economic growth.
The plaintiffs, including the American Bankers Association, U.S. Chamber of Commerce, and Ohio banking organizations, argue that the current stress testing regime acts as a hidden regulation, restricting business financing and ultimately affecting Main Street businesses that rely on bank lending. They contend that the increased borrowing costs and reduced access to capital resulting from the opaque stress tests hinder economic growth and job creation. These organizations highlight the significant role banks play in financing businesses and governments, emphasizing that the capital markets, influenced by the stress tests, are the primary source of funding for the majority of U.S. businesses and governmental entities.
The lawsuit emphasizes that the plaintiffs do not oppose stress testing or capital requirements in principle but seek reforms that bring the process into compliance with established legal procedures and promote greater transparency. They argue that the Federal Reserve’s actions not only violate federal statutes but also impede rational decision-making and undermine the efficacy of the stress tests themselves. They believe that a more transparent and participatory process will yield more accurate and less volatile capital requirements, ultimately benefiting the broader economy.
The legal action comes shortly after the Federal Reserve acknowledged the “evolving legal landscape” and signaled potential changes to the stress tests to improve transparency. While the BPI considered this an “important first step,” the lawsuit proceeds to ensure legally sound and effective stress testing practices in the future. With a looming statute of limitations, the plaintiffs filed the suit to preserve their legal rights and aim to ensure that future stress tests, beginning in 2026, comply with all legal requirements, including public notice and comment procedures for significant changes to the framework. The lawsuit ultimately seeks a balance between robust risk assessment and the need for a transparent and predictable regulatory environment that supports economic growth and access to capital.
