Wall Street’s largest banks will face a hypothetical scenario of a severe global recession with heightened stress in both commercial and residential real estate markets as part of a Federal Reserve exercise to test firms’ ability to withstand crises.
(Bloomberg) — Wall Street’s largest banks will face a hypothetical scenario of a severe global recession with heightened stress in both commercial and residential real estate markets as part of a Federal Reserve exercise to test firms’ ability to withstand crises.
The central bank will examine the ability of the 23 biggest US lenders to weather crisis conditions without degrading their capital to dangerous levels. For the first time, the so-called stress test will feature an “exploratory market shock” to the trading books of the largest and most complex banks. The new component won’t be counted in the capital requirements affected by tests, the Fed said.
The tests were put in place after the 2008 financial crisis to ensure the US banking system could withstand the next crisis and are aimed help ensure that large banks are able to lend to households and businesses, even in a severe recession. They also evaluate estimating bank losses, revenues, expenses, and resulting capital levels—which provide a cushion against losses—under hypothetical recession scenarios into the future.
Under the regulator’s scenario, the US unemployment rate will rise to 10%. The tests, which will also involve changes in corporate debt markets, are not forecasts and should not be interpreted as predictions of future economic conditions, the Fed said.
The annual exams are closely watched by the financial industry because passing scores can effectively give banking giants a green light to return billions of dollars to investors in dividends and share buybacks. The results of the stress may also result in changes to large banks’ capital requirements. All the lenders tested in 2022 passed.
Fed Vice Chair for Supervision Michael Barr has said the central bank is considering changes to take into account new forms of financial stress as part of a broad look at lenders’ capital requirements.
Compared to a year prior, this year’s scenario features a greater increase in the US unemployment rate. It also poses a larger and more rapid decline in house prices, the regulator said. The 2023 tests will feature a higher starting level of interest rates.
(Updates with details of the scenarios, context starting in fifth paragraph.)
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