Michael S Barr: Multiple scenarios in stress testing

Speech by Mr Michael S Barr, Vice Chair for Supervision of the Board of Governors of the Federal Reserve System, at the Stress Test Research Conference, hosted by the Federal Reserve Bank of Boston, Boston, Massachusetts, 19 October 2023.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Thank you for the opportunity to speak today. I'm here to offer my thoughts on the next steps for stress testing, and in particular why using multiple exploratory scenarios will help improve our understanding of risk in the banking system.

The stress test as we know it today grew out of the 2009 Supervisory Capital Assessment Program, or SCAP, conducted in the heat of the global financial crisis. In the winter of 2008–09, markets had lost confidence in banks amid wide uncertainty about the future path of the economy and the losses banks could face. This prompted the Federal Reserve and Treasury to conduct a stress test to determine the health of the 19 largest banks under a severely adverse economic scenario and to publish the findings. The release of the results provided transparency about the status of the largest banks, made it easier for firms to re-capitalize themselves, and restarted the provision of credit to the economy that began the process of recovery.

Following the success of this stress test, Congress mandated in the Dodd-Frank Act that the Federal Reserve conduct an annual stress test of large banks to determine whether those banks have sufficient capital to absorb losses under adverse economic conditions. And today this test-as well as the data collection that supports it-is one of our primary tools to assess and to help ensure banks' resilience, in good times and bad. During periods of economic or financial uncertainty, stress tests can provide critical assessments of bank resilience to supervisors, the market, and policymakers. This transparency helps enable markets to function better in times of stress.