National banks and federal savings associations have gotten a bit of a regulatory reprieve courtesy of changes to stress-testing requirements finalized by the Office of the Comptroller of the Currency on Oct. 2.

Previously, banks with assets of just $10 billion or more had to conduct annual stress tests, a requirement imposed in the wake of the financial crisis that occurred more than a decade ago. Now, that threshold has increased to $250 billion in assets before “company-run” stress-testing requirements kick in.

The OCC’s recent action also lightens the burdens on the regulated community in other ways. National banks and federal savings associations with assets greater than $250 billion may perform stress tests less frequently and only have to address two rather than three stress-testing scenarios.

The OCC’s final rule becomes effective Nov. 24, 2019.

Driving the change

The OCC’s action stems from the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) last year, a law intended to roll back what some saw as an overly burdensome regulatory environment created by the 2008 financial crisis and Congress’ subsequent enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank required banks to conduct stress tests to make sure they hold sufficient capital should another economic crisis occur.

Larger banks, those that might be considered “too big to fail” should another devastating financial scenario come to pass, must continue to conduct their own stress tests under the OCC’s new rule. “The 2007-2009 financial crisis highlighted the problem of ‘too big to fail’ (TBTF) financial institutions—the concept that the failure of a large financial firm could trigger financial instability, which in several cases prompted extraordinary federal assistance to prevent their failure,” the Congressional Research Service wrote in a report on the EGRRCPA.

But saving too-big-to-fail institutions may not only be unfair to other outfits—doing so also creates a “moral hazard,” the CRS wrote in its assessment of the 2018 legislation. If creditors and others associated with a too-big-to-fail institution “believe that the government will protect them from losses, they have less incentive to monitor the firm’s riskiness because they are shielded from the negative consequences of those risks,” the CRS wrote. Requiring stress testing of these organizations helps make sure they have the means to endure a crisis.

A break for bigger banks, too

While smaller national banks and federal savings associations do not have to self-administer stress testing under the OCC’s new rule, larger ones still do—but on a less frequent basis. The EGRRCPA eliminated the general requirement that covered organizations conduct stress tests annually and instead deemed that such testing need only be conducted periodically. The OCC has interpreted this new requirement for “periodic” rather than annual testing to mean, generally, every two years.

A biennial stress test will likely still provide the OCC with “information that is sufficient to satisfy the purposes of stress testing,” the OCC wrote in the preamble to its final rule. According to the OCC, stress tests yield information that:

  • assists in an overall assessment of a covered institution’s capital adequacy;
  • identifies risks and the potential impact of adverse financial and economic conditions on the covered institution’s capital adequacy; and
  • determines whether additional analytical techniques and exercises are appropriate for a covered institution to employ in identifying, measuring, and monitoring risks to the soundness of the covered institution.

Certain banks consolidated under holding companies must still conduct a stress test every year.

The stress tests themselves previously covered three scenarios reflecting economic and financial conditions: baseline, adverse, and severely adverse. That requirement now has been reduced to just two: baseline and severely adverse scenarios. Results of stress tests must be reported to the OCC and to the Board of Governors of the Federal Reserve System.

A safety net?

Should trouble loom, the federal government can still act despite having eased the regulatory burden on banks via this latest action. “In the event of a sudden, material change in bank or market conditions or forecasts, the OCC retains its ability to require more frequent stress testing,” the OCC wrote in its final rule.

Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.