After SVB, Why Is the Fed Still Letting Large Banks Skip Annual Stress Tests?

First Citizens Bank (First Citizens) now holds more than $230 billion in assets. Many of those assets were acquired by purchasing the assets of Silicon Valley Bank (SVB)—the bank whose failure in 2023 caused the most significant banking crisis since the 2007-09 global financial crisis (GFC).

Yet under the Federal Reserve’s (Fed) current stress testing framework, First Citizens may not receive a stress test-based capital requirement (known as the stress capital buffer or SCB) above the minimum 2.5 percent floor—the same capital buffer requirement applied to community banks—until October 2028, five years after acquiring SVB and more than six years after crossing the $100 billion asset threshold that triggers higher standards, including the stress test.

It is indefensible that First Citizens, one of the largest and fastest-growing banks in the country, will go years without being subject to the SCB, a part of the capital framework the Fed describes as central to “ensuring resilience.”

The lesson of the GFC and the 2023 crisis was that supervisors should use the tools granted to them through legislation more aggressively and more consistently. Rapid growth, major acquisitions, and significant changes in business models are precisely the circumstances where more supervisory scrutiny is warranted and in the public interest. SVB tripled in size between 2019 and 2021 yet was never subjected to a single supervisory stress test before it failed. Under the Fed’s framework, SVB would not have received its first SCB until 2024—a full year after its collapse. First Citizens is now larger than SVB was at its failure.

However, in the aftermath of SVB’s failure, Fed officials repeatedly pointed to the Economic Growth, Regulatory Reform and Consumer Protection Act (EGRRCPA) as a reason why some large regional banks were no longer subject to the same stress-testing requirements as the largest Wall Street firms. EGRRCPA replaced annual stress testing for banks between $100 billion and $250 billion in assets—so-called Category IV firms—with a requirement that they be tested “periodically.” The Fed chose to interpret that as a stress test every two years for Category IV firms but importantly provided itself the authority to apply the stress test to a Category IV firm more frequently if circumstances warranted. Treating First Citizens as a routine Category IV firm—entitled in effect to years between meaningful stress test results—is difficult to defend based on SVB’s failure.

According to the Fed’s actual practice in recent years, the gap in banks’ stress testing can stretch considerably longer than the two-year period. First, the Fed has made this year’s stress test results consequence-free, waiving any adjustments to the associated SCB capital requirements while the Fed makes structural changes to the stress testing framework that will further reduce its dynamism and effectiveness. Second, the Fed has provided an overly lengthy stress test onboarding period for firms that cross the $100 billion asset threshold, a timeline that should be much tighter considering the risks that come with large and growing banks (see, for example, Synchrony Financial, which the Fed similarly extended its SCB application by multiple years).

In the Dodd-Frank Act, Congress directed the Fed to do a better job of supervising large banks after the failures that led to the GFC and gave the Fed broad authority to apply enhanced prudential standards, increase supervisory scrutiny, and require additional stress testing when circumstances warrant, which was maintained for banks over $100 billion even after the 2018 rollbacks in EGRRCPA. Therefore, the lighter-touch stress testing regime for banks between $100 billion and $250 billion was ultimately a choice made by the Fed, and it owes the public an explanation for why it is not exercising its authority to apply its stress test to banks of the same size whose failure triggered an emergency government intervention to protect their uninsured depositors just three years ago.

Governor Barr’s post-mortem on SVB concluded that tailoring “reduced the coverage and timeliness” of stress testing and that higher regulatory requirements “would likely have bolstered the resilience of Silicon Valley Bank.” Barr and former Chair Powell committed to revisiting that framework in addition to Barr’s other recommendations to strengthen the resilience of large banks. But the Fed, as extensively documented by Better Markets, has since moved in the opposite direction.

The Fed should reject proposals that would further tailor or reduce the application of the SCB and should instead require annual supervisory stress tests for banks that newly enter Category IV—whether through organic growth or acquisition—and maintain those annual tests until supervisors can conclude that the institution is well-managed and has a risk profile consistent with less frequent stress testing.

If another large regional bank fails after years without a meaningful stress test affecting its capital requirements, the Fed will have a difficult time arguing that Congress left it powerless to act.