Stress tests are ‘most significant’ regulatory outcome of crisis – Hirtle

The stress-testing framework is the most significant regulatory achievement to come out of the 2008 financial crisis, New York Fed research director Beverly Hirtle said on October 9.

In a speech looking back at the design choices around stress-testing, Hirtle noted there was an urgent need to assess the capital needs of banks in 2009, but banks were unwilling to be the first to break ranks and admit they needed more capital.

By requiring banks to raise more capital if their ratios fell below certain target levels under a hypothetical scenario rather than a forecast, the tests addressed first-mover problems, Hirtle said.

“In fact, all but one of the banks required to raise new capital were able to do so, some of them in amounts greater than the [stress test] requirements, suggesting that the [stress tests] created a ‘safe’ environment for banks to enhance their capital positions,” Hirtle said.

To improve stress tests in the future, Hirtle recommended a few “tactical” and “strategic” research avenues. Tactically, central banks could investigate how to improve supervisory models and model risks. Strategically, researchers should investigate big-picture questions, such as whether the tests vary appropriately over the credit cycle and whether they might encourage a “model monoculture”, she said.