Fed's Bowman outlines stress test changes and SVB review

Federal Reserve Vice Chair for Supervision Michelle Bowman said the central bank will consider final revisions to its stress testing framework in the coming weeks. She also expects finalization of changes to risk-based capital requirements and the surcharge for global systemically important banks.

Bowman made the remarks during a Friday luncheon in London, where she also provided an overview of a new independent review of Silicon Valley Bank's failure. An advocacy group sued Bowman and the Fed last week over the capital-requirements changes, which were proposed in March.

Considering stress test changes

Bowman highlighted two specific public comments on stress-test rules that she will consider for the upcoming final rule. One comment suggested establishing a fixed date to freeze banks' balance sheets before the Fed releases its annual stress-test scenarios, with an unfreeze shortly after. Another recommended creating two global market shock scenarios within the test, using the larger loss to calculate a bank's stress capital buffer.

For the 2027 stress test, Bowman wants public feedback on a revised model to evaluate noninterest income. This refers to fee and trading revenue banks earn from activities like wealth management, investment banking, and market making.

"In finalizing these reforms, we will finally close the book on an opaque and unnecessarily unpredictable framework," Bowman said on Friday.

Pushing for better communication

Bowman advocated for more communication between large banks and the Fed regarding stress testing. She argued that scenario analysis becomes more powerful when it is not a one-way exercise, noting that large banks already design and assess their own predicted performance under severe scenarios.

"The Fed’s stress tests should do more for our supervisors than calculate a single capital requirement," Bowman said. Fed stress tests should also identify a firm’s vulnerability to various material financial and nonfinancial risks before those risks emerge.

She applied this analysis to the failure of Silicon Valley Bank. Bowman stated that had the Fed applied this type of analysis, supervisors could have measured the effect of stressful scenarios on SVB's portfolios and capital positions much earlier. A plausible recession scenario with rising interest rates would have shown the firm's capital falling below required levels as early as the fourth quarter of 2021.

Supervisory failures in SVB collapse

Bowman delivered an assessment of an independent review of SVB's 2023 failure. The review concluded that the Fed's supervisory staff knew, or should have known, of the bank's vulnerabilities as early as March 2022.

The central bank's staff did not take prompt, decisive action to encourage or require SVB to reduce its interest rate risk or concentration of vulnerabilities, according to Bowman. The review cited a long-standing culture of risk aversion at the Fed, where staff believed it was safer to take no action than risk taking the wrong one. Supervisory staff were also unsure who had the authority to make the final call on corrective actions.

Bowman emphasized that SVB's collapse was not the fault of one entity. She said the failure fundamentally shook public confidence in the effectiveness of bank supervision, a loss that demands a response. The review aims to learn lessons from the past to avoid repeating them, not to assign blame.