By Pete Schroeder
WASHINGTON (Reuters) - Federal Reserve Vice Chair Randal Quarles cautioned Thursday that needed efforts to provide more economic stimulus could obscure risks at banks by helping keep borrowers afloat temporarily.
In prepared remarks, Quarles also said the Fed should take into account how bank risk is impacted by broader developments, like the growing role of nonbank finance, in further honing its annual stress tests of large firms.
"The Fed must continue to innovate so that stress testing remains effective," he said.
Quarles said he backed government efforts to support people and businesses amid the pandemic. But he warned they could mask underlying weaknesses at banks by making it unclear whether borrowers were able to keep up with loans with their own finances or due to government support. He said the Fed must figure out how to measure the pandemic's economic impact on borrowers in its future risk assessments.
Over the longer term, Quarles also said the Fed was considering ways to "reduce the volatility" in the annual stress tests without making them easier. Some issues being explored relate to gripes raised by banks around the treatment of interest rate hedges, loss-sharing agreements, and loans that use fair value option accounting, he added.
Quarles also reiterated that the Fed's bank supervisors should use as much data-driven analysis as possible in doing their work. The Fed's top regulatory official is currently working on an overhaul of how the central bank supervises large firms, after years of industry complaints the process is too opaque and subjective.
"I believe that there is room for supervisors to be more transparent about their analytical processes in general, and more forthcoming about the data used as the basis for supervisory judgments," he said.