The Government Accountability Office ("GAO") issued a report containing recommendations to improve the effectiveness of stress test programs performed pursuant to regulations promulgated by the Board of Governors of the Federal Reserve System ("Federal Reserve"). Report recommendations focus on improving disclosures, communication, scenario design choices and model risk management.

The GAO explained that the Federal Reserve conducts: (i) Dodd-Frank Act Stress Tests ("DFASTs") for banking institutions with more than $10 billion in total consolidated assets; and (ii) Comprehensive Capital Analysis and Reviews ("CCARs"), which use DFAST information to assess the capital adequacy (a quantitative assessment) and capital planning processes (a qualitative assessment) for bank holding companies with total consolidated assets of $50 billion or more. The GAO noted that the "Federal Reserve generally agreed with the recommendations and highlighted select and ongoing efforts."

Recommendations from the GAO report include:

  • the heads of the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency ("OCC") should harmonize their agencies' approach to granting extensions and exemptions from stress test requirements;
  • the Federal Reserve should remove company-run stress tests from the CCAR quantitative assessment;
  • the Federal Reserve should publicly 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;
  • the Federal Reserve should (for future determinations to object or conditionally not object to a company's capital plan on qualitative grounds) disclose additional information about the reasons for the determinations;
  • the Federal Reserve should publicly disclose, on a periodic basis, information on capital planning practices observed during CCAR qualitative assessments, including the practices the Federal Reserve considers stronger or leading practices;
  • the Federal Reserve should improve policies for official responses to CCAR companies by establishing procedures for notifying companies about the time frames relevant for Federal Reserve responses to company inquiries;
  • the Federal Reserve should assess – and adjust as necessary – the overall level of severity of its "severely adverse scenario" by:
    • establishing a process to facilitate proactive consideration of levels of severity that may fall outside of the U.S. postwar historical experience; and
    • considering the trade-offs associated with the different degrees of severity;
  • the Federal Reserve should assess whether one "severely adverse supervisory scenario" is a sufficient basis to inform decisions on CCAR and to promote resilience of the banking system;
  • the Federal Reserve should develop a process to test its proposed "severely adverse scenario" for pro-cyclicality on an annual basis before finalizing and publicly releasing the supervisory scenarios;
  • the Federal Reserve should apply its model development principles to the combined system of models used in the supervisory stress tests;
  • the Federal Reserve should create an appropriate set of system-level model documentation, including an overview of how component models interact and key assumptions are made in the design of model interactions;
  • the Federal Reserve should design and implement a process to test and document the sensitivity and uncertainty of the model system's output (the post-stress capital ratios used to make CCAR quantitative assessment determinations) including, at a minimum, the cumulative uncertainty surrounding the capital ratios and their sensitivity to key model parameters, specifications and assumptions from across the system of models;
  • the Federal Reserve should design and implement a process internally for communication of information to the governors during CCAR deliberations regarding the range and sources of uncertainty surrounding the post-stress capital ratio estimates; and
  • the Federal Reserve should design and implement a process for the governors and senior staff to articulate the tolerance levels for key risks identified through sensitivity testing and for the degree of uncertainty in the projected capital ratios.

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