The Federal Reserve formally approved a major overhaul of its annual bank stress tests by a 6-1 vote, closing the book on years of lobbying by Wall Street's largest banks.

On September 30, the Fed officially approved two final rules aimed at enhancing the transparency of stress tests and public oversight, while reducing the volatility of related capital requirements. The two rules are largely consistent with the proposals released for public comment in 2025.

Under the new rules, the Fed will publicly seek comment on stress test scenarios and significant model changes, and will update its hypothetical scenario framework, testing calendar, and global market shock components. The Fed said the changes are expected to reduce the annual volatility of capital requirements by roughly 50% and will not have a material impact on overall capital requirements.

The sole dissenting vote came from Fed Governor Michael Barr, who warned that the overhaul would "significantly weaken the stress tests, and in turn weaken banks' resilience." Former Fed official and Better Markets banking policy director Christopher Appel also expressed skepticism about the reform's actual effectiveness.

The Fed Board of Governors conducts stress tests periodically to ensure large banks hold sufficient capital and can continue lending steadily to households and businesses even during a severe economic downturn. Previously, in December 2024, the Board announced it would refine the methodology of its stress testing framework to further strengthen the financial system's resilience.

Core Changes: Greater Transparency, Two-Year Averaging Set to Begin

Fed Vice Chair for Supervision Michelle Bowman said in a statement that the reforms "preserve the resilience of the stress tests by ensuring their transparency, granularity, and risk sensitivity," and that the public will receive stronger assurance that the risks banks take on are properly reflected in stress losses and capital requirements.

The content of the two final rules is largely consistent with the 2025 proposals.

First, the Fed will annually invite public comment on stress test scenarios and significant model changes, and will simultaneously update its hypothetical scenario design framework, adjust the testing calendar, and update the global market shock component applicable to large trading-book banks. Affected banks will undergo two sets of global market shock tests each year, and the Fed will calculate results based on the scenario that produces the largest losses.

Second, when calculating stress capital buffer requirements, the Fed will use the average of the two most recent annual test results for institutions that have participated in stress tests for two consecutive years. To ensure that only models that have been subject to public comment are used in the calculation, this averaging mechanism will take effect starting in 2028.

The Fed also announced it is seeking public comment on improving its non-interest income models, aimed at better capturing differences in how different banks' business models generate revenue, with a 60-day comment period after publication in the Federal Register.

Industry Battle: Litigation Accelerated the Reform

The overhaul is the result of years of pressure from the banking industry.

The stress testing regime was established after the 2008 financial crisis to assess the capital adequacy of large banks under hypothetical recession scenarios.

The Fed announced in December 2024 that it would revise the tests, but that same month industry groups representing institutions such as JPMorgan Chase and Goldman Sachs filed suit against the Fed, seeking greater transparency and participation in the rulemaking process.

Organizations including the Bank Policy Institute and the American Bankers Association welcomed the new rules, saying in a joint statement:

Transparency and public participation have produced a better stress testing framework, helping to improve accuracy, enabling regulated banks to engage in more prudent capital planning, and delivering positive benefits for the national economy.

Opposing Voices: Tests Risk Becoming an "Empty Ritual"

Although the reforms received broad support, critics still questioned their direction.

Fed Governor Michael Barr argued that the overhaul would substantially weaken the binding force of stress tests, thereby reducing the overall resilience of the banking system.

Former Fed official Christopher Appel took a more fundamental critical stance, arguing that the Fed should not continue to rely on "this increasingly hollow exercise" to set capital requirements, but should instead use stress testing as a flexible supervisory tool to identify vulnerabilities, challenge bank assumptions, and drive corrective action.

Earlier this year, large banks once again all passed their annual stress tests, and immediately returned capital to shareholders on a massive scale, with the amounts distributed through dividends and share buybacks breaking the record set in 2019.