The Federal Reserve today released the three economic and financial market scenarios that it will use in the next round of the Comprehensive Capital Analysis and Review process for the nation’s largest financial institutions and foreign firms with U.S. operations. As advocated by the American Bankers Association, the Fed noted that it would exclude from the 2019 cycle firms between $100 billion and $250 billion in assets as a result of the S. 2155 regulatory reform law, which calls for these firms to be examined “periodically,” instead of annually. This “off-year” would serve to transition these firms to an extended stress test cycle.
The three scenarios — baseline, adverse and severely adverse — include 28 variables such as GDP, unemployment rate, stock market prices and interest rates. The baseline scenario is in line with average projections from surveys of economic forecasters.
Under the severely adverse scenario, the world would plunge into a severe recession, which would cause U.S. unemployment rates to rise to 10 percent, accompanied by elevated stress in corporate loans and commercial real estate markets.
Firms with large trading operations will participate in an additional test of reactions to a global market shock. Firms with substantial trading or processing operations will be required to incorporate a counterparty default scenario. Capital plans must be submitted to the Fed by April 5.
Along with the scenarios, the Fed finalized several changes intended to bring additional transparency to the stress testing exercises. These include providing an enhanced disclosure of the models the Fed will use to estimate hypothetical losses; a stress testing policy statement outlining the Fed’s approach to model development, implementation, use and validation; and changes to the Fed’s framework for designing economic scenarios.
In related news, the OCC today also released its scenarios for banks and savings associations currently subject to the Dodd-Frank Act stress tests.
