THE US Federal Reserve released hypothetical scenarios for its annual stress tests, which seek to evaluate the resilience of big banks and ensure they can keep lending even in a severe recession.
This year, 22 banks will be tested against a global recession with heightened stress in both commercial and residential real estate markets, in addition to corporate debt markets, the central bank said on Wednesday (Feb 5).
Of the banks set to be tested, only eight with large trading operations will face a global market shock component.
In the 2025 stress-test scenario, the US unemployment rate would rise almost 5.9 percentage points to 10 per cent. That hike would come with severe market volatility, widening corporate bond spreads, a 33 per cent drop in housing prices and a 30 per cent decrease in commercial real estate prices.
The Fed also released two hypothetical elements designed to probe risks through its “exploratory analysis” of the banking system. That analysis is separate from the stress test and will explore other possible risks to the banking system. It will not affect the lenders’ capital requirements.
One part of that analysis will examine how banks would react to credit and liquidity shocks in the non-bank sector during a severe global recession. The second tests the largest and most complex banks. It looks at the hypothetical failures of five large hedge funds, along with reduced global economic activity and higher inflation.
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Vice-chair for supervision Michael Barr has previously said he wants to broaden the scenarios in these annual tests to gauge whether big banks can weather shocks and still keep lending. Barr announced last month that he will step down from his role as the Fed’s top bank cop on Feb 28, or earlier if a successor is confirmed.
In December, banking and business groups sued the Fed over the central bank’s annual stress tests, saying they want more transparency and input into how the rules are adopted. They argued the criteria for the tests are designed in secret and produce “vacillating and unexplained requirements and restrictions on bank capital”.
The Fed has said it plans to overhaul its stress tests of big banks to smooth out changes in required capital levels from year to year.
President Donald Trump last week assailed the Fed’s approach to bank regulation and accused Chair Jerome Powell of fumbling the fight against inflation. BLOOMBERG