The Federal Reserve plans to make significant adjustments to the annual bank stress tests according to a legal ruling.

The Federal Reserve on Monday said that, in light of recent developments in the legal realm, it is considering significant adjustments to its annual bank "stress tests," including allowing banks to comment on the models they use. This is a major victory for Wall Street banks. The Fed indicated that it may also allow banks to provide feedback on the assumptions used in the annual bank check-ups and may average the results over two years to reduce the yearly fluctuations in how much capital banks must set aside to absorb potential losses. These tests were established after the 2007-2009 financial crisis to evaluate whether large banks can withstand economic shocks. They are at the core of the U.S. capital system, determining how much cash banks must hold in reserve to absorb losses and how much cash they can return to shareholders. The Fed stated that the proposed reforms are not aimed at affecting overall capital requirements but are being proposed in light of significant changes in the administrative law framework following recent court rulings. The Fed said, "Given the evolving legal landscape, the Board has been analyzing its current stress testing regime and is committed to making important modifications to enhance its flexibility." In June of this year, the U.S. Supreme Court overturned a decades-old precedent known as the Chevron doctrine in the Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. case. The Chevron principle required courts to defer to an administrative agency's "reasonable" interpretation of its regulations, even if the court had a different interpretation of the regulations. However, in June, the Supreme Court ruled that courts do not have to defer to an agency's interpretation of the law, even when the language of the regulation is ambiguous. This ruling dealt a significant blow to federal regulatory authority. Despite the Dodd-Frank Act passed in 2010 requiring the Fed to test bank balance sheets after the financial crisis, the capital adequacy analysis the Fed conducts as part of the stress tests, or the capital it instructs banks to set aside as a result, is not legally required. Analysts suggest that the overturning of the Chevron doctrine makes the stress tests more susceptible to litigation. According to industry sources and public records of meetings between industry groups and the Fed, Wall Street banks and their industry groups in Washington have been quietly lobbying this year to increase transparency around the stress tests. These discussions are part of a broader industry effort to mitigate the impact of the Basel Endgame and raised capital requirements. In response, Wall Street banks took the unusual step of threatening to sue the Fed and two other federal agencies responsible for drafting the rule. Banks have traditionally been reluctant to sue federal banking agencies, but as U.S. courts increasingly accept industry lawsuits alleging federal agency overreach, they have become more emboldened. The industry group Bank Policy Institute (BPI), which has been critical of the stress tests, stated in a release that Monday's statement was "a first step towards transparency and accountability." BPI President and CEO Greg Baer said, "We are carefully reviewing it and considering other options to ensure timely reform that is both good law and good policy."