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 2022 stress test results:
The annual DFAST 2022 stress test results released today demonstrate that large U.S. banks are highly resilient in the face of an extreme stress scenario. Despite the sharp deterioration in economic and financial conditions assumed in this year’s stress test scenario, banks still had more than twice the minimum capital required. As a result, large banks continue to be in an excellent position to lend to households and businesses and support U.S. economic growth.
The scenario considered in this year’s stress tests is much more severe than any post-World War II recession, including the 2007–2009 global financial crisis. To be precise, this year’s stress scenario assumes a 5¾-percent jump in the unemployment rate, accompanied by a 3½-percent decline in real GDP. The scenario also includes a collapse in asset prices: a nearly 40-percent fall in commercial real estate prices, a 28-percent drop in house prices, and a 55-percent decline in the stock market. This year’s scenario also featured more severe trading shocks for several benchmark indexes compared with last year’s. The Federal Reserve has also tested large banks’ resilience to rising interest rates through higher Treasury rates and MBS spreads in this year’s global market shock.
The tougher assumptions in this year’s stress scenario resulted in higher projected loan losses compared with last year’s stress tests. Lower allowances for credit losses at the start of the stress tests raised projected provisions for loan losses further. For the banks subject to the global market shock, the more severe shocks in this year’s scenario drove increased trading and counterparty losses. By contrast, projections of pre-provision net revenue rose compared with last year’s test. However, the increase in banks’ balance sheets during the pandemic continued to cause the Federal Reserve’s projections to overstate noninterest expenses (including losses from operational-risk events) and a few fee income components.
Overall, the maximum decline in the aggregate common equity tier 1 capital ratio increased 0.3 percent compared with DFAST 2021, which will likely translate into higher stress capital buffer requirements for many of these banks in the fall – in other words, this year’s stress test will result in higher capital requirements for U.S. banks. Raising bank capital requirements as the economy slows down due to higher interest rates will cause banks to tighten lending standards at the wrong time and could undermine the Federal Reserve’s objective of avoiding a recession in the U.S. economy over the next year. In addition, the volatility in capital requirements from year to year hinders banks’ ability to manage their capital effectively and the need for banks to hold extremely high levels of capital both to be above all regulatory capital buffers and account for the volatility of stress tests comes at a real cost of economic growth.
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.