Banking industry trade groups, including the Bank Policy Institute (BPI) and the American Bankers Association (ABA), have filed a lawsuit against the Federal Reserve claiming the agency's annual stress tests lack transparency and adequate public input.
Launched on Tuesday, the complaint was registered in the U.S. District Court for the Southern District of Ohio. It does not aim to abolish the existing stress tests or capital planning requirements established after the 2008 financial crisis, but instead seeks to mandate public engagement during the design phase of these tests. The trade groups assert this engagement is required under federal law.
Historically, these annual stress tests require banks to demonstrate their resilience against hypothetical adverse economic conditions. Given the potential consequences of poor test results—such as restricted capital distributions—the groups argue for more transparency throughout the process. The lawsuit is being backed by prominent entities such as the U.S. Chamber of Commerce and several Ohio local trade organizations.
According to Greg Baer, CEO of the BPI, the absence of public input leads to “capital charges” which are often “inaccurate, volatile and excessive,” stifling lending and economic growth. Baer emphasized the importance of transparent procedures stating, “The current opaque regime… continues to produce capital charges…” This sentiment from industry advocates indicates widespread concern about the impact of Federal Reserve policies on the banking sector.
The complaint arises at a time when banks are facing heightened scrutiny and regulatory challenges. Just one day before the lawsuit was filed, the Federal Reserve announced it intends to adjust its approach to stress testing for 2025, including proposals to adopt averages of resilience over two years instead of one year. This announcement came amid recent changes to administrative law emphasized after the Supreme Court's June decision eliminating judicial deference to regulators.
While the Fed unveiled plans for potential improvements in transparency relating to future stress tests, industry leaders remain wary. The lawsuit itself is formulated to preserve the banks’ right to pursue legal remedies should the Fed’s changes not meet their expectations. “We remain hopeful the Fed will address long-standing issues with the stress tests,” stated Rob Nichols, ABA chief executive, asserting their litigation reflects both urgency and caution.
Historically, the Fed utilizes stress test results to set stress capital buffers, which serve as financial safeguards against potential market shocks. If banks underperform in these assessments, they may face restrictions on stock buybacks and dividend payouts, which can significantly impact their financial stability and shareholder relations.
The issue of transparency surrounding stress tests is not new. Critics, including the plaintiffs of this lawsuit, have long maintained the procedures governing these tests are laden with secrecy, causing operational challenges for banks. The banking industry’s growing readiness to legally contest regulatory authority, especially against the backdrop of changing legal precedents, reflects significant tension between financial institutions and regulatory frameworks.
According to Reuters reporting, the lawsuit ties to potential threats to the operational efficacy of the financial systems, citing fears around “opaque and subjective” outcomes of the stress tests as central to the concerns. The trade groups are advocating for the models and scenarios used by the Fed to be made public and subject to feedback, as is typical under the Administrative Procedure Act—a standard which they argue the Fed has failed to uphold.
Despite the recent Fed announcement indicating its willingness to amend some aspects of its stress testing process over concerns raised by the industry, the trade groups are proceeding with the lawsuit. Legal representatives from Porter Wright Morris & Arthur LLP and Gibson Dunn & Crutcher LLP represent the plaintiffs and indicate this action remains significant for the overall banking regulatory ecosystem.
Future adjustments to the stress testing framework could reshape capital requirement assessments. Stress tests dictate how much capital banks retain and influence strategic financial decisions, including dividends and stock buybacks. The outcome of this legal battle may have long-lasting effects on the banking sector’s ability to navigate regulatory expectations.
This lawsuit is emblematic of broader shifts within the regulatory sphere, as banks leverage recent judicial decisions to contest practices perceived as legally questionable. The outcome may redefine the extent of public participation and oversight within financial regulatory processes.
With the upcoming stress testing procedures set for 2025, the industry is preparing for what could be transformative changes, all hinging on the balance between regulatory authority and banking resilience.
