The Federal Reserve's stress test faces a Wall Street lawsuit demanding transparency.

Fed and Wall Street Clash Again: Transparency of Stress Tests in Focus

Wall Street Lawsuit: Accusing Fed of Lack of Transparency

On Tuesday local time, the Bank Policy Institute (BPI) officially filed a lawsuit in court, accusing the Federal Reserve of serious lack of transparency in its annual stress testing procedures. This industry group represents several large financial institutions, including JPMorgan Chase, Bank of America, Goldman Sachs, and Morgan Stanley. The lawsuit states that the Fed's actions lead to significant and unpredictable capital requirement fluctuations for the banking industry, negatively affecting the stability of the financial system.

The lawsuit clearly states that Wall Street does not oppose the stress tests themselves but demands that the Fed increase transparency. The Bank Policy Institute emphasized that "non-transparent stress tests could impose unexpected capital burdens worth billions of dollars on individual banks, negatively impacting the overall economy."

Background: Stringent Regulation Causes Banking Industry Dissatisfaction

The Federal Reserve's stress tests are crucial for assessing whether banks possess sufficient capital in adverse economic conditions. The most recent test simulated a 40% drop in commercial real estate prices and a 36% drop in residential prices. If banks perform poorly, the Fed may require them to increase capital reserves or restrict dividend distributions and stock buybacks. However, the banking industry is dissatisfied with the way this process is executed. Goldman Sachs CEO David Solomon bluntly said, "The volatility of results makes it difficult for us and our peers to manage capital prudently."

As early as 2023, when the Fed proposed new capital rules (the final version of Basel III), Wall Street quickly organized opposition. This fall, the Fed temporarily slowed down proposed capital increase requirements. However, Wall Street is clearly not satisfied with the current state, and this lawsuit is undoubtedly a new round of confrontation against the Fed's regulatory policies.

Fed "Backs Down": Stress Test Policies Might Be Revised

Perhaps foreseeing the lawsuit, the Fed announced after Monday's market close that it will make significant changes to bank stress tests and seek public input. The Fed stated that it plans to increase transparency and reduce the volatility of test results through adjustments. Nonetheless, Bank Policy Institute CEO Greg Baer expressed that despite the Fed taking this first step, the "lawsuit is still necessary to protect our legal rights."

Future: Regulatory Relaxation or Intensified Confrontation?

The Fed's announcement did not address substantive changes in capital requirements, causing the banking industry to worry that the current stringent regulations will not be significantly relaxed. Meanwhile, Dennis Kelleher, president of the US economic think tank Better Markets, warned that overly publicizing stress test models could make the process "manipulatable," thus weakening the tests' rigor and independence.

The Trump administration's transition team is also exploring the possibility of reducing Wall Street regulation, which may have a significant impact on Michael Barr, the current vice chair responsible for Fed supervision. His term will expire in 2026, providing the Trump team an opportunity to nominate his successor and potentially bring changes to banking regulatory policies.

Conclusion: Confrontation Will Continue

The confrontation between the Fed and Wall Street has escalated from policy discussion to legal action. In the future, with adjustments in stress test policies and potential changes in Fed leadership, the direction of banking industry regulation remains highly uncertain. This struggle is not only about the stability of the financial system but could also become a key factor in shaping the future of the US banking industry.

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