Washington, D.C. — Bank Policy Institute Executive Vice President and Head of Research Francisco Covas issued the following response to the Federal Reserve’s release of the 2023 stress test results:
The 2023 Federal Reserve stress test results released today demonstrate that large banks in the U.S. are highly resilient to a severe stress scenario. Overall, the maximum decline in the aggregate common equity tier 1 capital ratio – a key metric in the test – decreased compared to last year’s tests. This decrease will likely translate into modestly lower capital requirements for the banks subject to the test.
There appears to be a significant misunderstanding among some media outlets and policymakers regarding the nature and purpose of the stress test results released today. The annual stress test is no longer a test that banks “pass” or “fail”; it no longer functions as a traditional supervisory exercise like the Supervisory Capital Assessment Program during the global financial crisis. Instead, since 2020, the hypothetical losses calculated for each bank are transformed into a capital charge that is added to each bank’s minimum capital requirements. Capital regulations limit the ability of banks that do not hold the required capital to distribute earnings to shareholders.
- Therefore, the stress test is now a capital regulation, albeit one that is calculated with almost no transparency and notice-and-comment process.
This year’s stress test scenario surpasses the severity of any recession since World War II, including the global financial crisis of 2007-2009. Given that the industry has just endured a real stress test, we appreciate the Federal Reserve’s decision not to introduce additional macroeconomic scenarios in this year’s stress tests. The Fed’s severely adverse scenario properly illustrates the effects of a highly severe recession, leading to substantial capital depletion for most participating banks. Conversely, a realistically framed scenario featuring rising interest rates, coupled with less marked economic and asset price declines, would lead to less capital depletion than the existing scenario, adding little new insight to the overall results. The examination process seems to be the most effective safeguard against interest rate risk, and we anticipate the development of improved guidance for this process.
About Bank Policy Institute.
The Bank Policy Institute (BPI) is a nonpartisan public policy, research and advocacy group, representing the nation’s leading banks and their customers. Our members include universal banks, regional banks and the major foreign banks doing business in the United States. Collectively, they employ almost 2 million Americans, make nearly half of the nation’s small business loans, and are an engine for financial innovation and economic growth.