Banks and Business Groups File Legal Challenge Against Federal Reserve Over Flawed Stress Testing Framework

The Bank Policy Institute, along with the American Bankers Association, the U.S. Chamber of Commerce, the Ohio Bankers League and the Ohio Chamber of Commerce today announced that they are filing litigation against the Federal Reserve, challenging the opaque aspects of the stress testing framework. While stress testing is an important risk management tool for banks and supervisors that helpsensure that banks have sufficient capital to withstand severe economic shock,thelawsuit seeks to resolve longstanding legal violations by subjecting the stress test process to public input as required by federal law. Stress testing has direct implications on banks' ability to support American households and businesses and harms the U.S. economy by slowing job growth, hindering capital markets intermediation and raising the cost of credit.

BPI: "For years, we have highlighted serious concerns about the stress testing framework and the need for reform. The current opaque regime, combined with the lack of clear standards for the global market shock and the operational risk charge, continues to produce capital charges that are inaccurate, volatile and excessive, resulting in reduced lending and economic growth. We appreciate the Board's announcement as a first step towards transparency and accountability, but believe it is necessary to file this suit to preserve our legal rights." - Greg Baer, President and CEO of the Bank Policy Institute

American Bankers Association: "While we support stress testing as an important risk management tool, ABA has long advocated for the Federal Reserve to increase the transparency of its stress testing program, which shields key components like supervisory models from public view. The opaque nature of these tests undermines their value for providing meaningful insights into bank resilience. To meet federal law, the Fed should publish the supervisory models and stress scenarios and invite public comment, which would enable banks and the public to better understand and prepare for regulatory expectations, reducing uncertainty and promoting a fairer, more predictable regulatory environment. 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." - Rob Nichols, President and CEO of the ABA

Ohio Bankers League: "The Ohio Bankers League, alongside other key industry organizations, is filing this lawsuit to ensure that the Federal Reserve's process is brought into compliance with federal statutes, including the Administrative Procedure Act, which mandates transparency and public participation. By bringing these issues to court, we are advocating for a fairer, more transparent framework that will allow our financial institutions to better serve Ohio families and businesses while promoting economic stability. This litigation is not about eliminating the stress tests but ensuring that the process is both legally sound and effective in promoting a healthy, growing economy." - Michael Adelman, President and CEO of the Ohio Bankers League

U.S. Chamber of Commerce: "Main Street businesses drive growth and job creation throughout the economy. Many of those Main Street businesses rely on bank lending to fuel that growth and manage their finances. The current stress test regime acts as a regulation and restricts business financing. Nevertheless, the stress tests were never submitted to public notice and comment and lacked the transparent administrative due process that rules must be subject to. As we have argued in the past, following those procedures would have demonstrated the negative consequences to job, wageand economic growth by restricting bank lending to businesses." - Tom Quaadman, Senior Vice President of Economic Policy for the U.S. Chamber of Commerce

Ohio Chamber of Commerce: "The American people deserve a fair and transparent process of stress testing for banks.The current system restricts access to capital for businesses and families, thus killing jobs and the American dream." - Steve Stivers, President and CEO of the Ohio Chamber of Commerce

Why now: The current Federal Reserve's stress testing framework is in violation of the law, as detailed in our complaint filed in court today. BPI and the co-plaintiffs have for years petitioned for improvements to the stress testing framework that would bring it into compliance with the law and make it a better tool for assessing risk. While the Federal Reserve has now acknowledged the problems with the framework and the need to bring it in compliance with the law, the co-plaintiffs could possibly forfeit the ability to challenge the stress test framework due to a statute of limitations date fast approaching in February of 2025. Since the statute of limitations on several of the agency actions establishing the framework for the stress tests expires in February 2025, we had no choice but to file this lawsuit in order to preserve our legal rights. So while yesterday's announcement is an important first step, filing preserves legal options going forward.

The background: Stress testing is an important risk management tool for banks and supervisors. It helps identify potential vulnerabilities and ensures that banks have sufficient capital to withstand severe economic shocks. Banks regularly conduct their own stress tests to assess their resilience and readiness for adverse economic conditions under a variety of scenarios. However, the Federal Reserve's stress testing framework violates both the Constitution and federal statutes such as the Administrative Procedure Act, which prohibit agencies from regulating in secret. The Federal Reserve conducts its stress tests without providing transparency into its models or scenarios.

• The APA requires public notice and comment for significant regulatory changes. Each year, the Federal Reserve's stress tests change the minimum capital banks must hold - often substantially, effectively acting as binding rules with significant capital implications, but these changes are made without giving notice and seeking public comment. Subjecting the work and thinking behind these capital charges to public scrutiny would allow errors, mistakes and poor policy choices to be clearly illuminated, and thus corrected.
• The current framework creates unnecessary uncertainty without benefit. Erratic stress test results and constant uncertainty around future regulations damage the banking system without making it safer. Each year, the stress test produces arbitrary, counterintuitive and sometimes inaccurate results that are inconsistent with more granular bank models and recent market experience.
• The lack of transparency and volatility in the results makes it difficult for banks to plan and manage capital effectively, leading to higher borrowing costs for their customers.
• The uncertainty also weakens banks' market-making and capital markets capacity, hurting a critical financing conduit for U.S. businesses and local governments. The capital markets services that the largest U.S. banks provide are essential for economic growth, with 75% of financing for U.S. businesses and government coming from the capital markets.

Bottom line: Without the legally required transparency that applies to other federal regulations, the stress tests amount to an illegal intervention into the cost of capital, with detrimental results for the economy. Although this legal action targets the stress test, its goal is not to eliminate it - only to subject its key components, both the scenarios and the models, to the benefits of public transparency through notice-and-comment rulemaking. To access a copy of the complaint, please click here.