The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Stephen Gandel

NEW YORK, June 24 (Reuters Breakingviews) - Wall Street’s annual exam is now consequence-free. Stress tests implemented by the Federal Reserve gauge how 32 large banks, including the likes of JPMorgan JPM.N and Goldman Sachs GS.N, would fare in a severe downturn. This year’s results, set to be announced on Wednesday, will no longer trigger automatic penalties for poor performance. The change might seem just another part of the Trump administration’s multi-front regulatory rollback. Making the proceedings less punitive could nonetheless free them to become more useful.

Inaugurated amid an economic crisis, the Fed’s first test in 2009 was arguably its most successful. Investors contemplating the financial system’s demise took confidence from an exercise they saw as rigorous and credible. Even though several banks failed the exam, the stock market surged over the following three months.

When annual tests became a requirement under 2011’s Dodd-Frank legislation, poor performance could lead to restrictions on dividends, share buybacks or other activities. The stakes rose in 2020, when then-Fed Vice Chair for Supervision Randy Quarles implemented the long-in-the-works stress capital buffer. Banks projected to suffer larger losses in a hypothetical downturn now had to hold more capital over the following year.

Wall Street hated this, since higher requirements sap returns. Curiously, though, their results have improved since. Before 2020, large banks on average were projected to lose 3.7 percentage points of capital in a stress scenario. In the following years, the average fell to just 2.5 percentage points.

Lenders may be teaching to the exam. A 2023 study led by University of Oklahoma economist Thomas Schneider found that large banks devote more effort to preparing for stress tests than to broader risk management, a perverse outcome for a process meant to make the system safer.

Harsher penalties also prompted backlash. Industry groups sued the Fed in 2024, eventually winning concessions that included access to regulators’ once-confidential models. Essentially, the exam went open-book. Given the bevy of changes still underway, this year’s results will not affect stress buffers.

This is the worst of all worlds. The tests are at their lowest ebb of rigor, consequence-free for now but still dangling the threat of capital charges in future years that will continue to catalyze industry revolt.

The fix may be to just suspend the buffer permanently. Stress tests were originally designed to reassure markets reeling from catastrophe. Having that tool in hand will be invaluable during the next crisis. Freeing it of political rancor in favor of renewed credibility would make it stronger when it counts the most.

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CONTEXT NEWS

The Federal Reserve will release the results of its annual stress test of the nation's biggest banks after U.S. stock markets close on June 24. In February, the Fed said it would not use this year's test to set capital requirements, but plans to resume doing so in 2027.