Federal Reserve Annual Stress Test

2023

The 2023 Federal Reserve stress test results 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.

The 2023 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.

The stress scenario assumed:

• A nearly 6½ percentage point increase in the unemployment rate.
• An 8¾ percent fall in real GDP.
• A 3½ percentage point increase in corporate BBB spreads.
• A 38 percent decline in house prices.
• A 40 percent drop in commercial real estate prices.
• A 45 percent drop in the stock market.
• A 75 peak value in the volatility index.

2022

Despite the sharp deterioration in economic and financial conditions assumed in the 2022 stress test scenario, banks still had more than twice the minimum capital required.

The tougher assumptions resulted in higher projected loan losses compared with 2021 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 the 2021 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.

The stress scenario assumed:

• A 6.2 percentage point increase in the unemployment rate, and one of unprecedented suddenness.
• A 7.8 percent fall in real GDP.
• A 3.5 percentage point increase in BBB spreads.
• A 26 percent decline in house prices.
• A 35 percent drop in commercial real estate prices.
• A 50 percent fall in the stock market index.

Other Content:

• BPI Comments on Federal Reserve Implementation of Capital Assessments and Stress Testing Reports
• BPI Statement on the Federal Reserve’s Release of the 2022 Stress Test Results
• Misunderstanding the Fed’s Stress Test: Cost & Consequences

2021

Due to the elevated capital levels of banks, all banks remained well above minimum capital requirements. As the Federal Reserve observes in its summary the average minimum common equity tier 1 capital ratio is more than double the banks’ minimum requirement. As a result, those banks will no longer be subject to restrictions on capital distributions beyond those envisioned by the stress capital buffer framework. These results also reflect the additional $90 billion in common equity tier 1 capital and $70 billion in allowances for credit losses that stress-tested banks have accumulated since the onset of the COVID event.

The stress scenario assumed:

• The unemployment rate would climb to 10.8 percent, exceeding the peak level reached in 2020’s June stress tests.
• Commercial real estate prices drop 40 percent over the planning horizon; and
• The stock market declines 55 percent.

Other Content:

• Reserve Balances, Noninterest Expenses, and Bank Performance in the Stress Tests
• Federal Reserve’s 2021 DFAST Results Again Demonstrate Resiliency of Large U.S. Banks
• Estimating the Implicit Capital Charges in the Stress Tests
• Fix Bank Leverage Requirements Now, in Advance of Upcoming Treasury Market Stress

2020

The Federal Reserve conducted two stress tests in 2020 in response to the COVID-19 pandemic.

The early-year stress scenario captured a severe global recession accompanied by vulnerabilities in commercial real estate and corporate debt markets. While the Fed’s sensitivity analysis was extremely severe. 75 percent of banks remained well above their minimum capital requirements at the end of the stress planning horizon.

The early-year stress scenario assumed:

• A 6.5 pp increase in the unemployment rate, larger than the 5 pp increase in the financial crisis.
• A 8.3% fall in real GDP, larger than the 3.9% fall in the crisis.
• A 4.0 pp increase in BBB spreads, about the same as in the crisis.
• A 28% decline in house prices, larger than the 22% decline in the crisis.
• A 35% drop in commercial real estate prices, a bit less than the drop in the crisis.
• A 50% fall in the stock market, larger than the 45% fall in the crisis.

The Federal Reserve published two stress scenarios (severely adverse and alternative severe) in September for use in the mid-cycle stress tests. The stress test results again demonstrated that large U.S. banks are highly resilient. Although the average maximum decline of regulatory capital ratios in these second stress tests exceeded the decline of capital ratios in the June exercise and two banks approached minimum risk-based requirements, we estimate that the average stress capital buffer would have remained unchanged if the Board had re-calculated SCBs based on these results. Moreover, our analysis of the stress test results indicates that the stress test projections understate the degree of resiliency of large U.S. banks in three ways.

Other Content

• An Overview of the Global Market Shock Component in the 2020 Stress Tests
• Supervisory Stress Tests for Loan Losses: A Five-Year Overview With Reflections on the Need for Greater Transparency
• Trading Revenue and Stress Tests

2019

These results assessed the performance of banks under stress, based on the Federal Reserve’s 2019 severely adverse scenario and bank balance sheets as of year-end 2018. The DFAST results also incorporate capital actions based on bank dividends paid in the prior year and with share repurchases assumed to be zero. The results found that stress capital buffers (SCB) reverted to 2016/2017 levels for most banks; the improvement in bank performance was in large part driven by projected gains in available-for-sale (AFS) securities and somewhat lower trading and counterparty losses; and Net revenues and loan losses under stress moved back to 2016/2017 levels. However, there was a significant increase in credit card loan losses, in part driven by changes in the Fed’s own models.

The stress scenario assumed:

• A 6.2 percentage point increase in the unemployment rate, and one of unprecedented suddenness.
• A 7.8 percent fall in real GDP.
• A 3.5 percentage point increase in BBB spreads.
• A 26 percent decline in house prices.
• A 35 percent drop in commercial real estate prices.
• A 50 percent fall in the stock market index.

Other Content:

• The Global Market Shock and Bond Market Liquidity
• Reducing Spurious Volatility in the Federal Reserve’s Supervisory Stress Tests

2018 and Earlier

On June 21, 2018, the Federal Reserve released the results of the 2018 Dodd-Frank Act Stress Tests (DFAST). The key takeaways from this DFAST results are as follows:

• Based on DFAST 2018 results, banks’ proposed stress capital buffers would rise 90 basis points in aggregate, from 3.0 percent (using DFAST 2017 results) to 3.9 percent.  For the GSIB group, the aggregate SCB rose 110 basis points, namely from 3.2 percent to 4.3 percent.
• The increase in capital requirements is likely to dampen loan growth at banks subject to the stress tests and reduce economic growth had the SCB been calculated using this year’s results.
• As a result of the increase in the SCB under the Fed’s proposal, the total amount of excess capital (the amount by which their capital exceeds the proposed requirements) at banks subject to the stress tests would decline approximately $85 billion, namely from $205 billion to $120 billion.

Other Content:

• The Fed’s Stress Tests May Have Left Banks More Exposed to Rising Interest Rates
• Stress Tests and Improvements to the CCyB Framework
• Stress Test Dummies: A Fundamental Problem With CCAR (and How To Fix It)
• A Transparent Method for Judging the Severity of Macroeconomic Stress Scenarios
• A Proposal to Improve the Transparency of Stress Scenarios
• Stress Tests and Capital Surcharges Are Curtailing Lending to Small Businesses in LMI Communities
• Fed’s Versus Banks’ Own Models in Stress Testing: What Have We Learned So Far?
• TCH Research Note Compares United States and European Union Stress Tests
• Comparing the Results of Stress Tests: CCAR 2016 Versus NYU Stern V-Lab Model

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