The results of the Federal Reserve’s annual bank stress test showed that while large banks would endure greater losses than last year’s test, they are well positioned to weather a severe recession and stay above minimum capital requirements, the Fed announced today.
This year’s stress test scenario included a severe global recession with a 40% decline in commercial real estate prices, a substantial increase in office vacancies and a 36% decline in house prices, according to the Fed. All 31 banks tested remained above their minimum common equity tier 1 capital requirements during the hypothetical recession, after absorbing total projected hypothetical losses of nearly $685 billion. As for the reasons for the larger capital decline, the Fed attributed those losses to substantial increases in banks’ credit card balances combined with higher delinquency rates, riskier corporate credit portfolios, and higher expenses and lower fee income in recent years.
The Fed also conducted for the first time an exploratory analysis that will not affect bank capital requirements. The two funding stresses analyzed included a rapid repricing of deposits, combined with a more severe and less severe recession. Under each element, large banks would remain above minimum capital requirements in aggregate, with capital ratio declines of 2.7 percentage points and 1.1 percentage points, respectively. Under the two trading book stresses analyzed, which included the failure of five large hedge funds under different market conditions, the largest and most complex banks were projected to lose between $70 billion and $85 billion. “The results demonstrated that these banks have material exposure to hedge funds but that they can withstand different types of trading book shocks,” the Fed said.
The latest stress test once again shows that U.S. banks remain healthy, highly capitalized and well prepared to weather a severe recession, including a dramatic downturn in commercial real estate under the Fed’s hypothetical scenario, ABA President and CEO Rob Nichols said. “The continued strength and resilience of the banking sector is further evidence that the recent tsunami of new regulation, including proposed higher capital standards, is unwarranted and would only hinder the ability of banks of all sizes to serve their customers, clients and communities,” he added.
