Banking and Finance Law Daily Wrap Up, FEDERAL RESERVE SYSTEM—Fed Governor Barr weighs in on maintaining “dynamism” in stress testing, (Sep 26, 2025)

By Steven Melendez

Barr argued for separating stress testing from the stress capital buffer in order to preserve flexibility in the stress testing process.

In a talk at the Peterson Institute for International Economics, Federal Reserve Governor Michael S. Barr spoke about the importance of stress testing since the 2008 financial crisis, suggesting a path forward for the process in the future.

“Stress testing ultimately succeeded in helping to restore confidence during the crisis, and in the aftermath this battle-tested tool became a formal and integral part of the effort to repair the ensuing damage and strengthen the banking system,” Barr said. “Stress testing has continued to evolve in the years since then to maintain that strength and help limit the chances of another devastating financial crisis.”

Stress testing history. In 2008, Barr said, questions about big banks' exposure to the mortgages and real estate at the center of the crisis led to investors “driving down the equity prices of banks, which complicated efforts by banks to bolster their balance sheets.”

As a result, the Department of the Treasury worked with the Fed to build what was called the Supervisory Capital Assessment Program (SCAP) to test 19 systematically important financial institutions. The SCAP stress tests, and later iterations, relied on a “severe but plausible scenario for macroeconomic conditions,” economic models that could translate that scenario into “quantified losses for each bank," and the ability to generate a “firm-specific amount of capital” needed to withstand such losses. The tests also relied upon public disclosure of the scenario, methodology and results, as well as “a qualitative supervisory assessment of the banks’ capital planning decisions and processes,” Barr said.

The initial SCAP program required 10 of the 19 tested institutions to raise capital, and they were given six months to develop plans to meet the test requirements. Banks stocks recovered after the stress test announcements, and banks were mostly able to stabilize and raise capital, Barr said.

Dodd-Frank-era stress testing. After the crisis and the passage of the Dodd-Frank Act, banks were subjected to what was called the Dodd-Frank Act Stress Test (DFAST) as stress testing was integrated into the Fed's Comprehensive Capital Analysis and Review (CCAR) program.

DFAST evolved from the SCAP, as "the Fed built a process to develop thematic forward-looking scenarios using macroeconomic models calibrated to historical data" and applied "models developed and operated by the Federal Reserve based on data provided by the banks," facilitating independent risk assessments, Barr wrote.

Big banks criticized CCAR as being "wholly separate from the process used to set a bank’s basic, risk-based capital requirements" and having "a lack of transparency and predictability that resulted in them pre-committing to lower capital distributions and higher levels of capital." The Fed responded, Barr wrote, by in 2020 introducing the stress capital buffer (SCB), which "combined the basic capital requirement for banks with one equal to a bank’s projected capital ratio decline during the stress test plus a year’s worth of planned dividends."

Some of the changes may have made the test less useful, Barr said.

“By more directly integrating stress testing into capital regulation, the SCB increasingly moved stress testing away from supervision and toward the regulatory arena, a consequential decision," he said. "While this change was intended to promote consistency and predictability, in retrospect, it may have reduced some of the value of the exercise, in that it reduced the range of facts and circumstances the Board would take into account when evaluating an individual firm’s capital adequacy.”

But overall, he said, under the stress-testing framework, banks have "more than doubled their risk-based common equity capital ratios—from roughly 5 percent to 12 percent or more" and made "meaningful improvements" in risk management.

Moving forward. In December 2024, Barr wrote, bank trade associations sued the Fed Board of Governors, arguing against "what they contend is the opacity of certain elements of the stress testing process." In response, he said, the Fed said it would disclose and seek public comment about the models and stress scenarios it uses in the tests and proposed averaging stress testing over two years to reduce volatility in capital requirements.

"These proposed changes represent a policy choice to respond to the litigation by enhancing transparency and promoting public participation, and they are not intended to materially affect overall capital requirements," Barr said. "But in my judgment, they are a mistake that will make stress testing less rigorous and nimble."

The risk is that the models could "ossify, and their dynamism and effectiveness may fade," with the notice-and-comment process making it hard to adjust them rapidly for new risks. Knowing details of the models and scenarios in advance could also enable gamesmanship by the banks, and predictable tests may cause banks to invest less in risk management, Barr cautioned.

Barr suggested separating stress testing from preliminary SCB calculations, with SCBs set according to other risk-based factors, which he argued would eliminate the legal backing for the notice-and-comment procedure. Stress test data could still be used over time to adjust the SCB standards.

"The Board could approach these statutorily required tests primarily as a supervisory exercise and could thereby retain flexibility to design and adjust the models and scenarios as appropriate to ensure their rigor and robustness," he said. "Moreover, as authorized by the Dodd-Frank Act, the Board could run multiple scenarios to provide greater dimension to the assessment of risks."

In "exceptional circumstances," the Fed could still impose specific capital requirements based on stress tests and other factors, Barr said.

Still, the Bank Policy Institute (BPI) criticized Barr's proposal.

“In his remarks today, Governor Barr proposes to abandon the Board’s current path towards a transparent and publicly reviewed stress test in favor of a black box, where capital increases are imposed in secret and subject to no governing standard or due process," said Sarah Flowers, senior vice president, head of capital advocacy, at the BPI. "We continue to believe that this approach is poor policy and not consistent with the law or the Board’s recent commitments to the public and a federal court. Capital requirements influence the cost of living for American consumers and businesses, making it critical to shed light on how those requirements are set.”

IndustryNews: FederalReserveSystem FinancialStability PrudentialRegulation