Federal authorities are reportedly working on expanding their stress test scenarios, as stated by Attorney General Barr.

The Federal Reserve, following the announcement by Vice Chair for Supervision Michael Barr on Thursday, is set to develop additional hypothetical scenarios for next year's stress test. The aim is to enhance the assessment of the resilience of large banks and the robustness of the financial system.

Currently, the Fed's annual stress test focuses on a credit-driven recession and a single global market shock. However, recent bank failures such as those of Silicon Valley Bank, Signature Bank, and First Republic Bank have highlighted the need for a more comprehensive approach.

In light of these events, Barr emphasized the need for the central bank's annual stress test to continue to evolve. He suggested introducing multiple exploratory scenarios into the stress test, including reverse stress testing, to measure a bank's resilience more effectively.

The new scenarios will not be used to set a bank's stress capital buffer requirement. Instead, they will serve to better probe the internal risk management of firms and assess whether they are holding sufficient capital for their risks.

Barr did not disclose the number of additional exploratory scenarios the Fed might add to next year's test. However, he emphasized that a relatively small number of scenarios may be sufficient to capture a wide range of outcomes for the banking system.

The Fed has already incorporated an "exploratory market shock" in this year's exam, aimed at testing whether the trading books of the eight largest banks could withstand inflationary pressures and rising interest rates.

All 23 banks examined in the 2023 stress test remained above their minimum capital requirements. This underscores the importance of the stress test, initiated after the 2008 financial crisis, which ensures that the country's largest banks can withstand a severe recession.

Barr stated that examining potential risks on bank balance sheets through exploratory scenarios would be beneficial for supervision. He further emphasized that these adjustments would help ensure that the stress test remains a powerful and relevant tool for assessing the resilience of large banks and the robustness of the financial system.

Such conditions, historically associated with subdued inflation and a fall in interest rates, will provide a challenging but necessary test for the banking sector. The Federal Reserve's commitment to evolving the stress test is a positive step towards maintaining financial stability in the face of an increasingly complex and interconnected global economy.

Federal authorities are reportedly working on expanding their stress test scenarios, as stated by Attorney General Barr.