Bank stress testing in the future will need to ensure that banks remain stable – which means the tests will need to “keep up” as the financial system evolves, the chairman of the Federal Reserve Board said in opening remarks Tuesday at a conference about the safety and soundness devices.
Jerome H. (“Jay”) Powell told the “Stress Testing: A Discussion and Review” research conference in Boston (via a four-minute video) that if stress tests do not evolve, the tests risk becoming “a compliance exercise, breeding complacency from both supervisors and banks.”
“We might also, inadvertently, encourage the development of a banking system where, over time, all banks would look much alike rather than the banking system we want and need, one with diverse institutions with different business models,” Powell said, adding: “We simply can’t let these things happen.”
Powell anticipated that, when the next episode of financial instability develops, “it may do so in a messy and unexpected way.” He said banks need to be ready for both expected and unexpected risks, asserting that stress tests will need to vary year from year and explore “even quite unlikely scenarios.”
The Fed, Powell indicated, considers stress testing as a cornerstone of the agency’s bank supervision and financial stability missions. “Stress testing is perhaps the most successful supervisory innovation of the post-crisis era. But if stress tests are to continue to serve their critical function, they will need to evolve in the years ahead to keep pace with the ever-changing financial system, as they have since the first round of tests in 2009,” he said.
Federal Reserve Board Chairman Jerome H. Powell welcoming remarks (via prerecorded video): “Stress Testing: A Discussion and Review;” research conference, Federal Reserve Bank of Boston, Boston, Mass.