There is a growing body of literature that examines the impact of stress testing and other changes to regulatory capital requirements (Basel 2.0, 2.5 and 3.0) on lending to various categories of borrowers. This is an important area of research, but in my view, it is somewhat incomplete in its focus. To begin, studies that focus on lending by banks participating in the CCAR/DFAST stress tests ignore the possibility of substitution of this activity to non-stresstested banks or to non-banks. This substitution effect could have significant consequences for both current economic activity and for systemic risk, channels that are important to understand in assessing the full impact of the programs. Some studies have looked more broadly at these substitution effects, but more work here – especially substitution into the non-bank sector – would be very helpful. Further, examining how lending has been impacted in the current economic environment of strong economic activity does not quite provide the full picture, as it does not address whether 6/8  BIS central bankers' speeches  these programs will be successful in mitigating spillovers, credit contractions and other negative outcomes during periods of stress. In assessing the costs and benefits of stress testing and other post-crisis regulations, it seems critical to assess not just current impact but outcomes over the cycle – something that is a challenge during a period of recovery and growth. A related set of questions concerns how stress testing affects the cyclicality of capital requirements and what degree of cyclicality is appropriate.

In reviewing the design choices, it’s also helpful to distinguish between choices about what the SCAP, CCAR and DFAST stress tests were designed to capture and how the models measure key elements of the stress test calculations. The first and most significant design choice involved what the tests would measure: the SCAP and subsequent U.S. supervisory stress tests measure the impact of the stress scenario on regulatory capital ratios. Other choices were possible, of course. The tests could have focused on modeling the market value of assets or equity (similar to the Capital Shortfall approach developed by Acharya et al. 5 , or attempted to measure the value or cost of debt, or the impact on credit ratings. But regulatory capital ratios were a natural choice, allowing the output of the stress testing exercise to map into the broader regulatory capital regime while addressing the slow adjustment of those ratios during downturns. The focus on regulatory capital ratios resulted in a cascade of additional design choices. To begin, since regulatory capital ratios are based on accounting definitions of earnings and capital, estimating net income and its flow through to regulatory capital became the focus of the stress test calculations. This stands in contrast to approaches that concentrate solely on projecting losses, which were the focus of much of the public discussion prior to the release of the SCAP results. In practical terms, the net income approach involves recognizing that banks will have non-credit-related expenses and earn revenues even during periods of stress.