Key takeout
The Federal Reserve can comfortably float in the event of a severe recession due to large cushions.
Annual stress tests, like in 2008, design troubling economic scenarios, except for the need for government support, to see if major banks can survive it. The latest results showed that banks such as JPMorgan Chase, Wells Fargo, Citigroup and Bank of America can comfortably withstand these blows and continue lending to homes and businesses.
“Large banks will remain well capitalized and resilient to a variety of serious outcomes,” Michelle Bowman’s vice-chairman for oversight said in a press release.
This year’s scenario was a little easier than 2024, but it was still marked by a brutal recession. The Fed tested the resilience of banks under unemployment, which peaked at 10%, with stock prices falling 50% and home prices and commercial property values ​​falling by around 30%.
That hypothetical recession would result in a loss of $550 billion to the 22 banks tested by the Fed as credit card users, businesses and other borrowers defaulted on loans. However, all of these banks maintain cushions well above the minimum level the Fed needs.
One important ratio used by the Fed will fall in terms of whether banks have sufficient capital from 13.4% at the end of 2024 to 11.6% across the industry. But that’s far above the 4.5% minimum requirement.
Other banks reviewed this year include lenders such as PNC Financial Services, Capital One Financial, US Bancorp, M&T Bank, and Truist Financial. The exam also includes major Wall Street banks such as Goldman Sachs and Morgan Stanley, as well as US branches of several large foreign banks.
The Financial Services Forum said in a statement that the results “confirm the strong capital position of the largest US bank.”
But Better Market, an advocacy group seeking stronger regulations, said that a 100% performance in testing shows that by improperly measuring bank risk in recessions, it “has no stress, ineffective, puts all Americans at risk.”
What’s next for the stress test?
The results are as the Fed is considering suggestions that it will destabilise banks’ annual results and lower other changes that are likely to be industry-friendly.
Banks have long claimed that the Fed’s process is opaque and has unpredictable outcomes, making banks unable to lend. However, critics say that some degree of opacity is exactly the point as testing becomes stricter and limits the bank’s ability to find workarounds.
The trade group sued the Fed in December on the issue. This is a fight that has since been suspended as the Fed is considering changing its annual exams. The Fed was partially bumped into by a Supreme Court lawsuit last summer.
On Friday, the Fed reiterated that it “will improve transparency in the stress testing process” by disclosing the model and predetermining the losses for the bank. The agency says the testing will lead to valuable feedback that can improve whether or not the risk is properly assessed.
The regulator also proposes reducing annual volatility of stress test results by obtaining average results over two years.
