Federal Reserve approves stress test reform by a 6-1 vote: Capital requirement volatility halved, sole dissenting vote warns of reduced resilience

The Federal Reserve has officially ended years of wrangling with Wall Street's largest banks by passing major reforms to its annual bank stress tests, with a 6-to-1 vote.

On September 30, the Federal Reserve formally approved two final rules aimed at enhancing the transparency and public oversight of stress tests, while also reducing volatility in related capital requirements. These rules are largely consistent with the consultation draft released in 2025.

According to the new rules, the Federal Reserve will seek public comment on stress test scenarios and major model changes, and will update the framework for scenario assumptions, testing calendar, and components of global market shock. The Federal Reserve stated that these changes are expected to reduce annual volatility in capital requirements by about 50%, without having a substantial effect on overall capital requirements.

The sole dissenting vote, Fed Governor Michael Barr, warned that the reforms would "significantly weaken the stress tests, thereby undermining banks' risk resistance." Former Fed official and Director of Banking Policy at the think tank Better Markets, Christopher Appel, also expressed skepticism about the real effect of the reforms.

The Federal Reserve Board regularly conducts stress tests to ensure that large banks have sufficient capital and can continue to lend to households and businesses even during a severe recession. In December 2024, the Board had already announced it would optimize the stress test methodology to further strengthen the resilience of the financial system.

Fed Vice Chair for Supervision Michelle Bowman stated in her remarks that the reforms "maintain the resilience of stress testing by ensuring transparency, granularity, and risk sensitivity," allowing the public to have greater assurance that risks taken on by banks are reasonably reflected in stress losses and capital requirements.

The content of the two final rules is basically consistent with the 2025 proposal.

First, the Federal Reserve will invite public comment annually on stress test scenarios and major model changes, while simultaneously updating the framework for scenario design assumptions, adjusting the test calendar, and updating the global market shock components for large trading book banks. Relevant banks will undergo two sets of global market shock tests each year, with the Federal Reserve using the scenario that results in the largest losses to calculate the test results.

Second, when calculating the stress capital buffer requirement, the Federal Reserve will average the results of the most recent two annual tests for institutions participating in consecutive years. To ensure only models subject to public comment are used in the calculation, this averaging mechanism will officially take effect in 2028.

The Federal Reserve simultaneously announced it would seek public input on improving the non-interest income model, aiming to better capture differences in revenue generation methods among different banking business models. The comment period will be 60 days following publication in the Federal Register.

This reform is the result of years of lobbying by the banking industry.

The stress testing system was established after the 2008 financial crisis to assess large banks' capital adequacy in the event of a hypothetical economic downturn.

The Federal Reserve announced revisions to the tests in December 2024, but in the same month, industry groups representing institutions such as J.P. Morgan and Goldman Sachs filed a lawsuit against the Fed, seeking greater transparency and involvement in the rule-making process.

The Bank Policy Institute and the American Bankers Association welcomed the new rules, stating in a joint statement:

Transparency and public participation have led to a more robust stress-testing framework, helping improve accuracy, allowing regulated banks to engage in more prudent capital planning, and bringing positive benefits to the national economy.

Despite broad support for the reforms, critics continue to question their direction.

Federal Reserve Governor Michael Barr believes the reforms substantially weaken the constraints of stress tests, thereby reducing the overall resilience of the banking system.

Former Fed official Christopher Appel takes an even more fundamental critical stance, arguing that the Fed should not continue to rely on "this increasingly hollow exercise" to set capital requirements, but should instead use stress tests as a flexible supervisory tool to uncover vulnerabilities, challenge bank assumptions, and drive corrective action.

Earlier this year, all large banks once again passed the annual stress test, and immediately after, returned record amounts of capital to shareholders through dividends and stock buybacks, breaking the historical record set in 2019.