Fed Finalizes Stress Test Overhaul to Halve Capital

The Federal Reserve Board has finalized a sweeping overhaul of its annual stress testing regime, a move designed to halve the year-to-year volatility in capital requirements for large banks. The changes, approved on September 30, introduce a new averaging mechanism and mandate greater public transparency in the testing process.

Vice Chair for Supervision Michelle W. Bowman stated the reforms preserve the system's resilience by ensuring it is "transparent, granular, and risk-sensitive." The two final rules largely mirror proposals from 2025 and have been welcomed by a banking industry that has long advocated for such revisions.

Core Components of the Final Rule

The overhaul rests on three main pillars designed to enhance transparency and stabilize capital demands. First, the Fed is now required to invite public input annually on any material changes to stress test scenarios or key models. Second, it updates the framework guiding the design of hypothetical scenarios, including revisions to the global market shock component applied to banks with large trading books. Third, multiple adjustments are made to the stress testing calendar.

For banks with significant trading operations, the update is particularly consequential. These firms will now be tested against two different global market shock components each year. The Fed will use the shock that produces the largest losses for each individual firm to calculate its final stress test results.

The Averaging Mechanism

The most significant change for capital planning is the introduction of an averaging requirement for the Stress Capital Buffer (SCB). When calculating this buffer, the Fed must now average the results from a bank's two most recent annual supervisory stress tests. This mechanism is intended to smooth out sharp annual fluctuations.

The Board will begin applying this averaging to stress capital buffer requirements in 2028. The delay ensures that only models which have incorporated the newly mandated public feedback are used in the calculations. The Fed estimates this change, combined with the other adjustments, will reduce year-over-year volatility in capital requirements by approximately 50 percent.

A Divided Vote and Industry Context

The final vote by the Board of Governors was not unanimous, passing by a margin of 6 to 1. The sole dissenter, Governor Michael Barr, argued that the new rules substantially weaken the stress tests and consequently undermine bank resilience. Barr had previously expressed caution toward calls for greater transparency, which intensified after industry groups sued the Fed following its initial announcement of planned changes in December 2024.

That lawsuit was brought by trade associations representing major Wall Street banks. The finalized rules align closely with the industry's demands for more predictable capital requirements and a voice in the process. For banks, the primary benefit is reduced uncertainty, making long-term capital planning significantly easier. The Fed has stated the changes are not expected to materially affect the aggregate level of capital requirements in the system.

Pending Proposal on Business Models

Alongside the final rules, the Fed has requested public comment on a separate proposal aimed at better capturing diversity in banks' business models. This revision targets the noninterest income model within the stress test, seeking to improve how it projects each bank's fee income under stressful economic conditions. If adopted, this model would replace the current one. The comment period will remain open for 60 days after publication in the Federal Register.

The stress test overhaul forms part of a broader series of reviews of the U.S. Capital regulatory framework, and discussions over the system's design are expected to continue.