The Government Accountability Office’s (GAO) latest report to Congress detailed various improvements needed for federal banking regulators to better ensure existing policies and procedures align with identified best practices. The report addressed concerns regulators identified related to stress testing, documentation, and cost-benefit analyses of rules and regulations, among others.
Since 2017, the Federal Reserve has tailored its stress tests to suit the risk profiles of financial institutions based on size and complexity while reducing the number of scenarios included in the testing process, the report stated. Representatives from 12 banks who provided feedback for the report generally viewed these changes positively, noting their appreciation for certain improvements from previous testing and regulatory regimes, such as the inclusion of more information on expected impacts from risk scenarios.
However, the representatives indicated more detailed information is needed on tests and the time frames for adhering to new capital requirements, resulting from test outcomes, are relatively short. The report highlighted analyses of 22 major capital and liquidity rules issued between 2012 and 2021, concluding these rules did not consistently reflect best practices for assessing banks’ resolvability in the face of serious threats to their financial stability.
Regulators often failed to identify alternative approaches or quantify benefits and costs, according to the report. The Fed provided little to no documentation for three of the 21 rules it was involved in. The report described these rules as follows:
- “For one rule lacking documentation, Federal Reserve staff indicated that an impact analysis was not conducted because staff believed the rule would have no immediate, direct impact. The rule aimed to remove the possibility of large future effects on subject firms by making more gradual any automatic limitations on capital distributions under certain capital rules.
- “For another rule lacking documentation, Federal Reserve staff provided us with a document that did not contain an analysis of the rule’s potential effects. The rule delayed the impact of a capital rule change to make time for a new, simplifying approach. Although the memorandum the staff provided analyzed the new approach (implemented in a subsequent rulemaking), it did not address the potential effects from the rule delaying the impact.
- “Documentation for the third rule consisted of an email and figures that lacked a narrative explanation of how the figures supported the analysis of the rule’s potential effects.”
For the other 18 rules assessed in the report, the Fed’s documentation lacked consistency in discussing methods, data, and conclusions, according to the GAO report.
The Bank Policy Institute expressed concerns about the GAO’s findings in a statement posted to the trade association’s website.
“Not only are transparency and cost-benefit analysis of rules essential to prevent government agencies from needlessly harming the economy, they are also required by law,” the trade group wrote. “As we have emphasized in our comments on the Basel Endgame proposal, the inadequate analysis underpinning regulators’ proposed capital increases is a failure of both law and policy. The lack of transparency and public comment in the Fed’s stress test models has yielded counterintuitive and varying outcomes, and we’re encouraged that the GAO is calling attention to it.”
One example of regulators failing to align policies and procedures with best practices highlighted in the report pointed to policy updates undertaken by two federal banking regulators but not the third. The updates were implemented by the Federal Deposit Insurance Corp. (FDIC) and the Office of the Comptroller of the Currency (OCC), respectively, in 2022 and 2021 to better align with leading practices. However, the Federal Reserve has not updated its policies since 1994, the report stated.
Specifically, the report stated that, “[t]he Federal Reserve’s rulemaking policies do not include certain key elements recommended by Circular A-4 for good regulatory analysis. For example, the regulator’s policies do not call for:
- “establishing a baseline against which to compare potential effects;
- “quantitatively or qualitatively assessing benefits and costs of the proposed rule (beyond a discussion of possible economic implications); or
- “documenting the data sources, assumptions, and methods used in an analysis.”
The report also stated the absence of requirements for benefit-cost assessments and proper documentation of data sources and analyses represents a significant gap in oversight. Updating these policies would help ensure the cost-benefit balance of rules and transparency in decision-making processes. Regulators conducted few retrospective reviews to assess the effects of existing rules, and despite the encouragement from Executive Order 13579 for independent regulatory agencies to have plans for such reviews, only the FDIC adopted a policy in December 2022 to conduct at least one annual review. The OCC and Federal Reserve lack similar policies.
The GAO recommended the Federal Reserve update its policies and procedures for regulatory analyses to align with leading practices and that both the OCC and the Federal Reserve develop policies for systematically performing retrospective reviews. The Federal Reserve agreed with the recommendations, while the OCC did not explicitly agree or disagree but indicated a commitment to address the recommendations.