Federal Reserve Vice Chairman for Oversight Michael Barr testifies before a House Financial Services Committee hearing on the response to the failures of Silicon Valley Bank and Signature Bank, on Capitol Hill in Washington, D.C., on March 29, 2023.
Kevin Lamarque | Reuters
The Federal Reserve said on Wednesday that the largest banks operating in the United States will be able to withstand a severe recession scenario while maintaining their ability to lend to consumers and businesses.
The US Federal Reserve said in a statement that each of the 31 banks that participated in the regulatory exercise this year succeeded in passing the hurdle of being able to absorb losses while maintaining capital levels above the minimum required.
The stress test assumes unemployment rates rise to 10%, commercial real estate values fall by 40%, and housing prices fall by 36%.
“This year’s results show that under our stress scenario, large banks would suffer aggregate notional losses of about $685 billion, yet still have capital well above the minimum requirements for common stock,” said Michael Barr, Fed Vice Chairman for Supervision. This is good news and confirms the benefit of the additional capital that banks have built in recent years.”
The Fed's stress test is an annual ritual that forces banks to maintain adequate protection for bad loans and limits the size of stock buybacks and dividends. This year's edition included giants such as C. B. Morgan Chase And Goldman Sachscredit card companies including American Express And regional lenders such as TRUE.
Although no banks defaulted significantly in this year's test, which had roughly the same assumptions as the 2023 test, the group's overall capital levels fell by 2.8 percentage points, which was worse than last year's decline.
This is because the industry holds more consumer credit card loans and more corporate bonds that have had their credit ratings downgraded. Lending spreads have also been narrowed compared to last year, according to the Federal Reserve.
“While banks are well positioned to withstand the specific hypothetical downturn we tested, stress testing also confirmed that there are some areas to watch,” Barr said. “The financial system and its risks are always evolving, and in the Great Recession we learned the cost of failing to acknowledge changing risks.”
The Fed also conducted what it called an “exploratory analysis” of funding stresses and trading collapses that applies only to the eight largest banks.
In this exercise, companies appeared to avoid disaster, despite the sudden rise in the cost of deposits that accompanied the recession. In a scenario in which five huge hedge funds collapse, the big banks would lose between $70 billion and $85 billion.
“The results show that these banks have material exposure to hedge funds, but they can withstand various types of trading book shocks,” the Fed said.
Banks are expected to begin announcing their latest stock buyback plans on Friday.
