# Fed’s outgoing CCAR chief defends stress tests

## Timothy Clark rebuffs US Treasury recommendations; supports more transparency

As the principal architect of the Federal Reserve’s stress tests, Timothy Clark deserves much of the credit for whipping the US banking sector into shape after the financial crisis. While it hasn’t always been popular with banks, the Fed’s Comprehensive Capital Analysis and Review has got results. For the first time since CCAR began in 2011, the Fed approved the capital plans of all 34 banks it stress tested in 2017 without objections – a testament to the industry’s newfound resilience and financial strength.

CCAR is not without controversy, however. To their many detractors, the stress tests are as unfair as they are arduous. Banks say they are overly burdensome, and accuse the Fed of being too secretive about its quantitative models and frustratingly vague in setting qualitative expectations.

Those concerns are shared by some in the US government. A Treasury Department report on regulatory reform published in June – prompted by the Trump administration’s pledge to review financial regulation – called on the Fed to disclose its CCAR models and to eliminate qualitative fails.

While the Fed exempted 21 smaller banks from the qualitative tests in this year’s CCAR, Clark, who is retiring from his post as deputy director of supervision and regulation at the Federal Reserve Board this month, disagrees with Treasury’s recommendation to do away with them entirely. “We don’t object to a firm on qualitative grounds because it forgot to dot an ‘i’ or cross a ‘t’,” he says. “This is fundamental stuff banks should have been able to do years ago.”

He also does not believe the Fed should reveal the inner workings of its models. Keeping the code secret prevents banks from defaulting to the Fed’s models, which by Clark’s own admission are less than perfect. “We don’t want the entire industry to just use our models,” he says. “We want them to use their own models and to innovate to create better models.”

For one thing, Clark says the Fed already provides a good deal of information on its models. Since 2016, an appendix describing the models used to project stressed capital and pre-tax income has been included in its annual CCAR disclosures.

Still, Clark says the Fed is considering disclosing the losses implied by its models for a set of hypothetical portfolios. This would permit a fairly accurate inference of the expected losses on any given set of assets, while ensuring banks are not able to game the models by scrutinising them for the precise points where they are weakest.

Clark says the idea, initially floated by former Fed governor Daniel Tarullo in an April 2017 speech, has some merit. “Showing the world indicative loss rates on these hypothetical portfolios would provide even more information on how different risk characteristics impact our model,” he says.

###### Nobody had a clue how far this knife was going to fall, but it was falling really, really fast. I’m not sure I got home in the summer of 2008. It was basically seven days a week for a few months

Clark also dismisses Treasury’s recommendation that the intermediate holding companies of foreign banks operating in the US be exempted from CCAR if their parent companies are stress tested by their national regulator. “In our IHC rule, what’s done in the home country is considered, but that does not negate the requirement that a local IHC do a stress test,” he says.

###### When we have all the firms focusing on identifying potential vulnerabilities in such a way they can continue to operate, that is macro-prudentially very sound

Clark emphasises the Fed adheres to the same supervisory guidance on model risk, called SR 11-7, that it expects banks to follow. A central oversight group consisting of senior Fed officials scrutinises the assumptions and outputs of the models used in the supervisory stress test. Models are reviewed by an independent validation team, which looks at the design and implementations of the Fed’s internal models. The reviewers are not involved in model development and report to a separate oversight group, while the control procedures surrounding model design are reviewed by yet another team of experts.

In the feedback letters banks received after this year’s stress tests, the Fed emphasised it wants to see improvements in the governance processes by which CCAR models and scenarios are reviewed and challenged at the business and board levels. Banks have admitted governance has historically taken a back seat to other aspects of CCAR. However, the quality of governance has improved recently, particularly among boards, which are paying closer attention to the calibration of variables that drive the results of the stress tests.

As Clark prepares to leave the Fed, he points to one area where there is still more work to be done: reconciling stress testing with resolution planning. A natural linkage exists between the two, in that understanding a bank’s vulnerabilities is a prerequisite to determining whether it may need to enter a resolution programme, and both require scenario-type forecasting.

“Trying to marry those directly can be massively complex,” he says.

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