Themistocles and the Mathematicians: The Role of Stress Testing
February 25, 2021
Vice Chair for Supervision Randal K. Quarles
Looking Ahead to the 2021 Stress Test
Continuing in that tradition, two weeks ago we initiated the 2021 stress test with the publication of this cycle’s stress scenarios. As we’ve said many times, the scenarios are not projections or predictions. They are designed according to a longstanding framework that we published after incorporating feedback from the public. This year, the macroeconomic scenario envisions a severe global recession accompanied by a period of heightened stress in U.S. commercial real estate and corporate debt markets. As discussed in recent financial stability reports, the current environment presents unique challenges for those asset classes, and our focus on them in the scenarios is consistent with the salient risks they pose to banks. The scenario layers additional significant stress on top of the stress already absorbed by banks over the past year, with the unemployment rate rising back to nearly 11 percent and stock prices falling more than 50 percent.
In March, we will publish the details of the methodologies that underlie our models. This will mark the third year since we enhanced the disclosures to provide significantly more information about the stress testing models relative to earlier years. That information includes ranges of loss rates, estimated by using the models, for actual loans held by CCAR firms; portfolios of hypothetical loans with loss rates estimated by the models; and more detailed descriptions of the models, such as equations and key variables that influence the results of the models. These disclosures enhance the ability of the public to understand and interpret the supervisory stress test results. And as I’ve noted before, I believe these enhanced disclosures have been a step in the right direction toward striking the right balance between rigor and transparency. They do not reveal everything about our models—lest we find ourselves in a “model monoculture” where supervisors and banks converge on the same sets of risks, ignoring other potential problems.
In June we’ll publish the firm-level results from the test. Though 2021 is a year in which smaller firms are not subject to the supervisory stress test, the Board recently made final a rule that will allow them to opt in. Should they do so, their results will also be disclosed, and their stress capital buffers will be updated using the stress test results we publish in June. These actions, including greater transparency around our stress testing models and greater flexibility in our stress testing process for smaller firms, represent innovations that I believe help to improve the effectiveness and efficiency of supervision.
The full speech is available at https://www.federalreserve.gov/newsevents/speech/quarles20210225a.htm