Big banks, business groups sue US Fed over annual stress tests

Major banks and business groups sued the Federal Reserve on Tuesday, alleging the US central bank’s annual “stress tests” of Wall Street firms violate the law.

The lawsuit filed in US District Court in Columbus, Ohio, claims the Fed’s practice of determining how big banks perform against hypothetical economic turmoil, and assigning capital requirements accordingly, do not follow proper administrative procedure. Plaintiffs included the Bank Policy Institute, the US Chamber of Commerce and the American Bank Association.

The lawsuit marks the latest example of the banking industry growing bolder and challenging in court their regulators’ powers, particularly in the wake of recent Supreme Court rulings placing fresh restrictions on administrative authority.

In June, the Supreme Court dealt a major blow to such power by overturning a 1984 precedent that granted deference to government agencies in interpreting laws they administer. The so-called “Chevron doctrine” had called for judges to defer to reasonable federal agency interpretations of US laws deemed to be ambiguous.

While the 2010 Dodd-Frank law passed following the global financial crisis broadly requires the Fed to test banks’ balance sheets, the capital adequacy analysis the Fed performs as part of tests, or the resulting capital it directs lenders to set aside, are not mandated by law.

Specifically, the groups are calling for the Fed to make public and subject to feedback the now-confidential models they regulators use to gauge bank performance, as well as details of the annual scenarios they create to test for weaknesses. The groups said they did not want to kill the stress testing programme, which provides an annual bill of health to the nation’s biggest firms, but argue the process needs to be more transparent and responsive to public feedback.

On Monday, the Fed announced plans to pursue similar changes ahead of the 2025 exams, citing recent legal developments, but the industry opted to proceed with its lawsuit. A Fed spokesperson declined to comment on the lawsuit on Tuesday.

“The opaque nature of these tests undermines their value for providing meaningful insights into bank resilience,” Rob Nichols, president and CEO of the American Bankers Association, said in a statement.

“We remain hopeful the Fed will address long-standing issues with the stress tests, but this litigation preserves our ability to seek legal remedies if the Fed falls short.” These tests, which banks have complained for years are opaque and subjective, are a central piece of the US regulatory bank-capital structure. The Fed has long resisted calls to completely open up the testing process, due to concerns that it could make it easier for banks to clear the exams.

How banks perform on the test informs how much capital they must set aside to meet their obligations and also dictate the scope of dividend payouts and stock buybacks.

The US Federal Reserve said on Monday it was considering major changes to its annual bank “stress tests” in light of recent legal developments, including allowing lenders to provide comment on the models it uses, in a major victory for Wall Street banks.

The Fed said it may also allow lenders to provide input on the hypothetical scenarios it uses for the annual bank health checks, and that it may also average results over two years to reduce annual volatility in how much capital banks must set aside to absorb potential losses.

The Fed created bank “stress tests” following the 2007-2009 financial crisis to assess whether big lenders could weather an economic shock. They are core to the US capital regime, dictating how much cash lenders must put aside to absorb losses, and how much they can return to shareholders.

The Fed said the proposed changes were not designed to affect overall capital requirements, but followed recent court rulings that have significantly changed the framework of administrative law in recent years, the Fed said.

“The Board analyzed the current stress test in view of the evolving legal landscape and determined to modify the test in important respects to improve its resiliency.” In June, the Supreme Court dealt a major blow to federal regulatory power by overturning a 1984 precedent that had given deference to government agencies in interpreting laws they administer. The precedent the court overturned arose from a ruling involving oil company Chevron that had called for judges to defer to reasonable federal agency interpretations of US laws deemed to be ambiguous.

While the 2010 Dodd-Frank law passed following the crisis broadly requires the Fed to test banks’ balance sheets, the capital adequacy analysis the Fed performs as part of tests − the resulting capital it directs lenders to set aside − is not mandated by law. (Reporting by Pete Schroeder; Editing by Mark Porter) Nicaragua mulls state control over leadership of private banks Dec 23 (Reuters) - Nicaragua’s legislature is set to vote on a bill overhauling the Central American nation’s banking system, which would give the state control over appointing the leadership at private financial institutions in the country.