GAO outlines 10 ‘high priority’ recommendations for Fed to take action on, including stress testing

Ten priority recommendations for the Federal Reserve, in three areas, are identified in a letter to the central bank by the congressional watchdog that “could significantly improve the Federal Reserve’s efforts to more effectively oversee risks to consumers and the safety and soundness of the U.S. banking system.”

The letter from the Government Accountability Office (GAO) – dated April 5 – to Federal Reserve Board Chairman Jerome H. (“Jay”) Powell cites the three areas as consumer protection for financial data aggregation services, derisking, and stress testing of banking institutions.

“The purpose of this letter is to provide an update on the overall status of the Board of Governors of the Federal Reserve System’s (Federal Reserve) implementation of GAO’s recommendations and to call your personal attention to areas where open recommendations should be given high priority,” the letter states. “As of January 24, 2019, the Federal Reserve had 34 open recommendations. Fully implementing these open recommendations could significantly improve the Federal Reserve’s efforts to more effectively oversee risks to consumers and the safety and soundness of the U.S. banking system,” the letter states.

Eight of the 10 “high priority” recommendations were contained under the stress-testing area, to assess how banks respond to adverse scenarios.

The GAO noted that in November 2016, it identified “some limitations in the areas of scenario design and model risk management,” including:

  • The Federal Reserve’s approach to designing stress test scenarios has not included analysis of whether the current approach, which uses one severe economic scenario rather than several, is sufficient to assess the resilience of the banking system, or proactively considered levels of severity outside of U.S. postwar historical experience. “Such analysis could help the Federal Reserve to ensure that it is not missing risks to the banking system and to guard against those risks,” the letter states.
  • The Federal Reserve’s risk management of its stress test models also has not included a focus on the risks associated with the system of models that produce the stress test results, in which the results of component models are combined with assumed or planned capital actions.
  • The Federal Reserve has not conducted sensitivity and uncertainty analyses of how its modeling decisions affect overall results, or developed a process for communicating information about uncertainty to the Board or a process for the Board and senior staff to articulate tolerance levels for key risks.

“We recommended that the Federal Reserve take steps to address the limitations in scenario design and model risk management,” the letter states.

Under financial data aggregation, the letter holds one “high priority” recommendation. The letter recommends that the Fed engage in “collaborative discussions” with other relevant financial regulators and stakeholders to reach “coordinated public outcomes” on issues surrounding financial account aggregation, particularly through financial technology (fintech) companies.

On “derisking” (the practice of banks limiting services or ending relationships with customers to, among other things, avoid perceived regulatory concerns about facilitating money laundering), the letter makes one recommendation: that the Fed jointly conduct a retrospective review of Bank Secrecy Act/Anti-Money Laundering (BSA/AML) regulations and their implementation for banks with the Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), and Treasury’s Financial Crimes Enforcement Network (FinCEN) and revise regulations or their implementation, as appropriate.

GAO Priority Open Recommendations: Board of Governors of the Federal Reserve System

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