Federal Reserve Chairman Ben Bernanke said in a recent speech that stress testing provides market participants with “deeper insight…into the financial strength of each bank,” adding that it forced banks to develop plans to ensure liquidity.
“The Supervisory Capital Assessment Program stands out for me as one of the critical turning points in the financial crisis,” Bernanke said in prepared remarks. “It provided anxious investors with something they craved: credible information about prospective losses at banks. Supervisors’ public disclosure of the stress test results helped restore confidence in the banking system and enabled its successful recapitalization. The resilience of the U.S. banking system has greatly improved since then, and the more intensive use and greater sophistication of supervisory stress testing, as well as supervisors’ increased emphasis on the effectiveness of banks’ own capital planning processes, deserve some credit for that improvement.”
The Federal Reserve has moved away from SCAP to rely on the Dodd-Frank Act stress tests—or DFAST—and the Comprehensive Capital Analysis and Review—or CCAR, both of which assess banks’ performance under adverse economic scenarios.
Bernanke said over the past four years, the aggregate tier 1 common equity ratio of the 18 firms who underwent the recent stress tests has more than doubled from 5.6 percent at the end of 2008 to 11.3 percent at the end of last year. He added that while stress tests focus on the largest banks, mid- and small-sized banks have also improved their capital positions.
“Higher capital puts these firms in a much better position to absorb future losses while continuing to fulfill their vital role in the economy,” Bernanke said.
Bernanke also said that the implementation of stress testing has made the banking system, and, in turn, the economy stronger.
“One of the most important aspects of regular stress testing is that it forces banks (and their supervisors) to develop the capacity to quickly and accurately assess the enterprise-wide exposures of their institutions to diverse risks, and to use that information routinely to help ensure that they maintain adequate capital and liquidity,” Bernanke said. “The development and ongoing refinement of that risk-management capacity is itself critical for protecting individual banks and the banking system, upon which the health of our economy depends.”