The Federal Reserve's annual stress test results released on Wednesday show that America's largest banks would be able to absorb over $708 billion in losses and continue lending to households and businesses during a severe global recession.
In the hypothetical scenario set by the Fed, all 32 banks examined maintained capital levels above the minimum regulatory requirements. This extreme scenario included unemployment surging to 10%, a 39% drop in commercial real estate prices, and a 30% decline in residential property values.
A key measure of the industry's ability to absorb losses during a downturn, the aggregate Common Equity Tier 1 (CET1) capital ratio, declined by only 1.6 percentage points in the test, remaining well above the required minimum. The projected losses for the tested banks were primarily comprised of approximately $200 billion in credit card losses, $160 billion in commercial and industrial loan losses, and $75 billion in commercial real estate-related losses.
Vice Chair for Supervision Michael Barr stated in a release that "today's results demonstrate the strength of the banking system."
This year's annual test coincides with a pivotal moment for bank regulation, as, unlike in previous years, the results will not influence the amount of capital large banks are required to hold.
This is because the Fed announced in February that the current stress test capital buffer requirements will remain unchanged until 2027 while regulators recalibrate the testing methodology. This move, made in response to industry complaints, could potentially reshape the capital standards financial institutions must maintain to weather economic downturns.
In a research note dated June 21, KBW analyst Christopher McGratty and his team described this year's test as a "procedural exercise," suggesting the banking industry is likely to focus its attention on the anticipated Basel III Endgame proposal expected later this year rather than the stress test results themselves.
KBW estimates that if this year's test results were factored into capital requirement calculations, firms such as Morgan Stanley, Citigroup, Citizens Financial Group, and KeyCorp would see the most significant reductions in their capital buffer levels.
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