Biggest Banks Can Withstand Severe Downturn, $685 Billion in Losses, Fed Says
Latest stress tests find banks remained above minimum capital requirements
WASHINGTON—Big U.S. banks passed their latest annual stress test, with the Federal Reserve finding they would be able to continue lending to households and businesses in a severe recession, even while suffering steeper losses than last year’s tests.
This year’s exercise measured the 31 biggest banks’ ability to maintain strong capital levels in a hypothetical recession marked by double-digit unemployment and a severe stock-market decline.
The banks would collectively lose nearly $685 billion in the Fed’s imaginary worst-case recession, the Fed said. That would be more than last year, but all the banks would still remain above their minimum capital requirements.
The banks were expected to lose more in this year’s test because they faced higher projected credit-card losses, riskier corporate loans and lower projected income, the Fed said.
The bank balance sheets are “somewhat riskier and expenses are higher,” Michael Barr, the Fed’s vice chairman for supervision, said in a statement.
“The goal of our test is to help to ensure that banks have enough capital to absorb losses in a highly stressful scenario,” he said. “This test shows that they do.”
The annual exercise aims to project confidence about the health of the banking system. If banks do poorly, they could face automatic restrictions on shareholder distributions and discretionary bonus payments. None of the banks face those limits after this round of tests.
Wednesday’s results could give banks and their lobbyists more ammunition to push back against large increases in capital requirements, which the Fed and other regulators have floated. Supporters of the plan say it will improve the overall resilience of the financial system after a spate of regional bank failures last year.
This year’s stress test included a severe global recession in which the U.S. unemployment rate jumps to 10%, housing prices crash by 36% and commercial real-estate prices drop by 40%.
Another wrinkle in this year’s tests, an “exploratory analysis” of the system suggests banks could withstand a repeat of the deposit crisis of 2023 or a potential catastrophe in hedge funds. The biggest banks could in the aggregate lose up to $85 billion if five big hedge funds failed, the Fed found.
Those scenarios have no impact on bank capital requirements.
The stress tests were introduced following the 2008-09 financial crisis, when the U.S. government bailed out some of the largest financial institutions. The results of the first tests helped restore investor confidence in the banking system.
Over the years, the annual stress tests have lost a lot of the stress they once had for big banks and are no longer as dreaded by bankers.
Daniel Tarullo, who oversaw bank regulation at the Fed from 2009 until 2017, said the tests have become more routine and predictable and questioned whether the Fed should continue to use them to set big banks’ minimum capital levels.