Fed’s Clark Says Stress Test Credibility Depends on Openness

Bank supervisors need maximum transparency in stress testing for such exercises to carry credibility with markets, said Timothy Clark, a Federal Reserve official who helped lead stress tests of the biggest U.S. banks.

“When you’re doing something like this you have to have credibility,” Clark said on a panel organized by the Institute of International Finance in Paris. “The expectations out there in the markets as you’re doing this are very high. You have to be prepared to be quite transparent, both in terms of scenarios you are using and the results.”

The Fed is stress-testing the largest banks and has set up teams to look for risks across financial markets and institutions, switching to a more industry-wide approach from one that looked at banks individually, while the European Central Bank is preparing a similar set of tests before it takes over supervision of euro-area banks next year.

Clark, a senior associate director in the Fed’s Division of Banking Supervision and Regulation, said today that the central bank’s key objective is to make sure banks can withstand financial turbulence.

The goal is for banks “to be able to withstand stress and be able to come out the other side able to function,” he said. It’s important that “we as supervisors and the firms themselves don’t forget that really bad things can and do happen.”

The Fed said in March that 17 of the 18 largest U.S. banks could withstand a deep recession and maintain capital above a regulatory minimum.

Chairman Ben S. Bernanke said in a May 10 speech that risks persist in wholesale funding markets used frequently by Wall Street brokers to finance securities trading.

The Fed chief has elevated market and institutional surveillance to an equal footing with macroeconomic research and forecasting, establishing the Office of Financial Stability Policy and Research headed by economist Nellie Liang.

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