Financial authorities are reportedly expanding their stress test scenarios, according to Attorney General Barr.

Michael Barr, the Vice Chair for Supervision at the Federal Reserve, announced on Thursday that the central bank will be adding new exploratory scenarios to its stress-testing process next year. This move aims to address current limitations by incorporating longer-term and more severe economic downturns, as well as climate-related financial risks and cyberattack scenarios.

The current stress test, put in place after the 2008 financial crisis, uses a single scenario focused on a credit-driven recession and a global market shock to test the financial condition of firms. However, Barr emphasized the need for the Fed's annual stress test to continue evolving, including the introduction of multiple exploratory scenarios.

The new scenarios will be exploratory and not used to set a bank's stress capital buffer requirement. They are intended to better probe the internal risk management of firms and assess whether they are holding sufficient capital for their risks. The Fed has already expanded the test by including an "exploratory market shock" in this year's exam.

Barr stated that reverse stress testing involves looking at a bank and determining the different ways it could face significant distress or failure. He suggested that a relatively small number of exploratory scenarios may be sufficient to capture a wide range of outcomes for the banking system.

The 2023 stress test results showed that all 23 examined banks remained above their minimum capital requirements. This year's exam aimed at testing whether the trading books of the eight largest banks could withstand inflationary pressures and rising interest rates.

The failures of Silicon Valley Bank, Signature Bank, and First Republic Bank illustrate that banking strains can emerge even without a severe recession. Barr did not disclose the number or specifics of the exploratory scenarios for next year's stress test.

The Federal Reserve's annual stress test is intended to remain a powerful and relevant tool for assessing bank resilience and financial system robustness, consistent with the original intent of the Dodd-Frank Act. The new scenarios are expected to make the test more comprehensive and better equipped to handle a variety of potential risks.