The Federal Reserve Board released results of its annual bank stress test, which showed that large banks are well positioned to weather a severe recession, while staying above minimum capital requirements and continuing to lend to households and businesses.
Under this year’s hypothetical recession, the aggregate decline in the common equity tier 1 (CET1) capital ratio, which provides a cushion against losses, is 1.8%. In April, the Fed proposed a rule to average stress test results over two consecutive years to reduce volatility from the stress test when calculating a firm’s capital requirement. If the Fed finalizes the rule as proposed, this year’s results would be averaged with the 2024 results, which would lead to an aggregate capital decline of 2.3%.
“Large banks remain well capitalized and resilient to a range of severe outcomes,” said vice chair for Supervision Michelle Bowman in a statement. “One way to address the excessive volatility in the stress test results and corresponding capital requirements is for the Board to finalize the proposal that would average two consecutive years of stress test results, which was released in April.”
All 22 banks tested remained above their minimum CET1 capital requirements during the stress scenario, after absorbing total projected hypothetical losses of more than $550 billion. Total projected losses of more than $550 billion include nearly $158 billion in credit card losses, $124 billion in losses from commercial and industrial loans, and $52 billion in losses from commercial real estate.
This year’s stress scenario is less severe than last year’s scenario due to the stress test’s countercyclical design. It includes a severe global recession with a 30% decline in commercial real estate prices and a 33% decline in house prices. The unemployment rate rises nearly 5.9% to a peak of 10%, and economic output declines commensurately.
There are three main factors that influence the results of this year’s test:
- Lower loan losses in a less severe scenario, due to the mild slowing of the US economy in 2024 and the countercyclical nature of the scenario design;
- Lower private equity losses due to adjustments of how these exposures are measured to better align with these exposures’ characteristics; and
- Higher net revenue due to the effect of improved bank performance and atypical trading positions as viewed through the lens of the supervisory stress test framework.