The Federal Reserve is considering changes to the annual stress tests it gives U.S. banks to move to a more risk-sensitive, firm-specific approach that would raise capital requirements for big banks based on their test results, according to its chair, Janet Yellen.
Testifying at a House of Representatives Financial Services Committee hearing on Wednesday, Yellen said the Fed is “now considering making several changes to our stress testing methodology and process.” The stress tests aim to prove that individual banks can withstand a massive financial crisis.
Under the changes the Fed is considering, banks would set capital requirements, called capital buffers, that banks must maintain to blunt the effects of a downturn based on the results.
“The existing capital conservation buffer would be replaced with a risk-sensitive, firm-specific buffer that is sized based on stress test results,” she said.
For the eight U.S. banks that are large and considered important to the global financial system the new buffer calculation “would result in a significant aggregate increase in capital requirements,” Yellen said.
Yellen did not comment on the outlook for the economy or monetary policy in her prepared remarks.
The chair’s remarks are the latest about possible changes in the central bank’s oversight of the country’s banking system, as Republicans in Congress criticize its regulation of financial institutions under powers it was given by the 2010 Dodd-Frank Wall Street Reform law.
Fed Governor Daniel Tarullo gave a detailed speech on potential reforms on Monday, and last week the central bank outlined a plan to limit Wall Street bets on the energy sector.
Yellen told the committee that, in general, large and regional banks are currently well-capitalized and profitable, and the Fed is seeing growth in commercial and industrial lending. Banks have faced some challenges in recent years because of weak growth in interest and noninterest income, she added.
Yellen also said Congress may want to consider making small community banks exempt from the Volcker Rule restricting their investments and the compensation limits in Dodd-Frank.
“The risks addressed by these statutory provisions are far more significant at larger institutions than they are at community banks,” she said. “In the event that a community bank engages in practices in either of these areas that raise heightened concerns, we would be able to address these concerns as part of the normal safety-and-soundness supervisory process.”