The U.S. Federal Reserve is forecasting just enough sunshine for bank stress tests. The central bank wants to provide more information about its models for loan losses and other inputs in the annual exams. That would suit lenders who complain the process is too opaque, but the Fed would also retain some mystery around the exercise.

Banks have long complained that the exercise is a black box. Regulators countered that firms could game the exams if they knew too much about the models used by the Fed. It’s been a testy fight because lenders can be barred from paying additional dividends if they fail. Particularly vexing for banks has been the qualitative part of the review, which assesses subjective issues like operational risk. Citigroup’s second failure in 2014 put CEO Mike Corbat’s job at risk.

Proposals issued by the Fed on Thursday to increase transparency would help banks and the public better understand how the watchdog assesses the industry’s risks. Under one of the plans, the Fed would shed more light on models for certain loans, such as corporate financing. The watchdog suggests providing additional disclosures on equations used in those models, along with the loan characteristics and economic variables that affect the model results.

The Fed is also considering publishing estimated loss rates under various scenarios for certain groups of loans, which would be the first time banks would see such models. The regulator also wants to provide more information about its hypothetical stress scenarios, such as housing prices.

But the Fed still keeps a lot of details under wraps. For example, it doesn’t propose to disclose its exact models and loss rates for mortgages or credit cards. That mitigates the prospect of banks loading up on certain assets to pass the test, which also reduces correlated risks if those holdings come under stress.

Wall Street critics worried that the first major reforms suggested under the Fed’s new vice chair of supervision, Randal Quarles, would be a gift to banks. After all, he was appointed by President Donald Trump, who promised to do a “number” on Dodd-Frank. But the Fed’s transparency proposals for the stress tests strike a good balance. That should boost the exam’s credibility.

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CONTEXT NEWS

- The U.S. Federal Reserve issued a proposal to increase transparency in the annual stress tests for the largest banks. The plan would make public for the first time certain details of internal models the Fed uses, including loan-loss rates.

- The Fed is also seeking comment on its “Stress Testing Policy Statement,” which describes its approach to model development, implementation, use, and validation. The board also proposes to modify the hypothetical economic scenarios under which banks are tested. The revisions include more information on housing-price scenarios. The Fed is also considering adding more variables to the test for funding risks in stress situations.

- These are the first suggestions of major regulatory changes under Randal Quarles, the central bank’s new vice chair of supervision. “This enhanced transparency will bolster the credibility of our stress tests and help the public better evaluate the results,” Quarles said. The Fed will seek public comment until Jan. 22, 2018 before the measures are finalized.

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(Editing by Tom Buerkle and Martin Langfield)

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