WASHINGTON — The Federal Reserve Board Thursday released its stress test scenarios Thursday, envisioning a widespread market cooldown and dramatic drops in asset prices.
As with the
Under this year's scenarios, large banks with significant custodial or trading volumes face an additional counterparty default scenario component to gauge potential losses and hits to bank capital if the firm's single largest counterparty defaults.
Financial institutions with substantial trading operations will also be subject to a 'global market shock' component that tests strain on these firms' investment holdings.
Thursday's release of the tests also included for the first time a four-part 'exploratory analysis' of the banking system to gauge banks' ability to withstand additional risks not traditionally captured in the stress tests. That's something regulators like Fed Vice Chair for Supervision Michael Barr have
Two of the exploratory analyses will probe the effects of funding stresses that induce swift repricing of deposits at big firms — the first set in the context of a moderate recession with rising inflation and interest rates, and the second in a global recession with persistently high inflation and rising interest rates. The other two of the four analyses will include two sets of market disruptions — under two sets of market conditions — applied to the most sophisticated U.S. banks and examining the impact of the failure of five large hedge funds on the largest banks.
In contrast to the stress tests, the analyses take a look at overarching economic impacts of such scenarios to the broader market rather than scrutinizing the effects on firms individually. The results of both the stress tests and exploratory analyses will be published later in the year in June of 2024.
Stress testing — one of the most consequential innovations to materialize from the 2008 financial crisis — has emerged as the Fed's leading supervisory exercise to assess the fiscal health of the largest banks.
The tests evaluate whether banks are positioned to keep their tier 1 capital-to-risk-weighted assets ratios above the required 4.5% minimum during the economic turmoil. Banks' hypothetical performance will determine the scale of its stress capital buffer, which acts as an added layer of loss absorption above the 4.5%.
Since 2015, global systemically important banks
This year's tests are the first iteration the Fed has announced since a historically turbulent year for the banking industry, which has endured a banking crisis in March of 2023, rising interest rates and strained valuations on commercial real estate among other stressors.
Banks with between $100 billion and $250 billion in assets are required to be subject to biannual tests. Thirty-two banks — an increased number — will be tested this year, compared with 23 banks in 2023.
Jaret Seiberg, an analyst with TD Cowen, wrote in a note that this year's tests are likely to increase banks' capital requirements.
"We expect these exploratory scenarios to force banks to boost capital," he wrote. "The funding scenarios focus on what happens when rates rise during a recession[;] that means banks face not only higher loan losses, but they also do not benefit from the impact of falling rates on their securities holdings and on a wave of loan refinancings."
Bank industry trade voices like Financial Services Forum President Kevin Fromer wrote upon release of the scenarios that this year's tests reinforce the industry's perspective that the largest firms — which are members of FSF — are strongly capitalized.
"This marks the 15th year since the Federal Reserve began to administer stress tests to gauge the health of the largest U.S. banks," he wrote in a release. "The stress test scenarios released today reflect a continuation of the highly rigorous standards applied to the largest banks."
