GAO Report Finds Flaws in Fed’s Stress Test Frameworks

Inadequate transparency, flaws in scenario design and model risk management issues surrounding the Federal Reserve’s Dodd-Frank Act Stress Test and Comprehensive Capital Analysis and Review programs could be limiting their overall effectiveness, according to a report released today by the Government Accountability Office.

The report highlighted a lack of transparency, particularly surrounding the Fed’s CCAR test — which applies to bank holding companies with more than $50 billion in assets — that GAO said may limit banks’ ability to fully understand the assessment and undermine public confidence in the findings. In addition, GAO noted that the Fed has not conducted sufficient analysis on its “severely adverse” scenarios, and pointed out that its model risk management efforts fail to focus on how “component modeling choices affected overall stress test results.”

“The Federal Reserve… continues to annually refine and develop its stress test models. However, limitations in analytical approaches and to disclosure present challenges to risk assessment by the Federal Reserve and to transparency,” GAO said. “In some cases, the Federal Reserve has not always followed its own guidance or principles.”

GAO made a total of 15 recommendations to the agency for improving its stress testing frameworks. The independent watchdog called on the Fed to work with the other federal regulatory agencies to harmonize their approaches to stress testing, and to remove the company-run stress test component from its CCAR test. GAO also recommended that the Fed improve transparency by publicly disclosing more detailed information on its methodology, decision-making process and “stronger or leading practices” observed during CCAR assessments, and establish procedures for responding to CCAR banks. In addition, GAO encouraged the Fed to re-assess and adjust its severely adverse scenario and design and implement processes and systems to better manage model risk.

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