The Federal Reserve may soon release more details about its stress tests, according to a footnote in its recently released instructions for the 2018 Comprehensive Capital Analysis and Review, or CCAR, cycle.
In its annual explanation of how to submit a capital plan, the Fed explained that companies should reflect the impact of the new tax law in financial statements and regulatory reports. But the Fed added that by March 1, 2018, it will publish a letter containing a "description of material enhancements to the supervisory models, including those related to the change in the tax law."
That would be another step in publicly sharing more granular detail on its internal stress-testing processes, long described by critics as "black boxes." In December 2017, the Fed outlined a proposal to release information such as estimated loss rates for specific types of loans. Public comment on the proposal closed Jan. 22, 2018.
Efforts to disclose details on stress testing have been a topic of conversation among Fed officials for some time. In September 2016, former Fed Governor Daniel Tarullo, who engineered the stress-testing regime, said the Fed was exploring opportunities to reduce the possibility of a large gap between the Fed's supervisory model and a bank's projections. But he pushed back on releasing the "full computer code," warning that full disclosure would "permit firms to game the system."
His successor as head of regulatory matters, Randal Quarles, has said that the recent round of public comments will begin the process of revealing the Fed's stress-testing program. In a Jan. 19 speech, he noted that he believes that disclosures "can go further," adding that he would like more visibility into the models that can bind a firm's capital levels. Quarles has not offered more specifics on what kinds of details he would like to see released.
Observers say they are eager to see the level of granularity in the supplemental letter to the 2018 CCAR instructions. Michael Alix, partner at PricewaterhouseCoopers, said in an interview that the letter will provide a trajectory for how much further detail the Fed will disclose in the future.
"I see this as incrementally increasing the transparency, yes, absolutely," Alix said.
Craig Brown, managing director in Deloitte's risk and financial advisory team, said he has similarly seen the Fed become more proactive in publicly explaining its CCAR process, particularly in the last three months. But he cautioned that the letter may not prove equally useful to all CCAR-filing firms.
"Does it assist the institutions? It depends on where their business lines are and what their revenue drivers are and where their risks lie," Brown said in an interview. "Each firm is different."
But as the Fed unveils more details about stress testing, some are beginning to wonder where the Fed should draw the line. Gregg Gelzinis, a research assistant at the progressive think tank Center for American Progress, said in an interview that disclosing too much would allow banks to tailor their balance sheets to minimize expected losses and decrease their capital.
"Revealing too much can undermine the efficacy of the test," Gelzinis said.
In his speech, Quarles appeared to recognize that modesty is key in stress-test transparency.
"I appreciate the risks to the financial system of the industry converging on the Federal Reserve's stress testing model too completely, so I am hesitant to support complete disclosure of our models for that reason," Quarles said.
