The nation’s 35 largest bank holding companies (BHCs), which represent some 80% of all U.S. bank assets, are strongly capitalized and would be able to lend to households and businesses during a severe global recession, according to stress test results released Thursday by the Federal Reserve Board.
The most severe hypothetical scenario projects $578 billion in total losses for the 35 participating bank holding companies during the nine quarters tested, the Fed reported.
This is the eighth round of stress tests led by the Federal Reserve since 2009 and the sixth round required by the Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act. The Federal Reserve uses its own independent projections of losses and incomes for each firm.
The planning horizon for this year’s stress testing begins in the first quarter of 2018 and ends in the first quarter of 2020. The Fed said results, in the aggregate, show the 35 firms tested would experience substantial losses under both the “adverse” and the “severely adverse” scenarios but could continue lending to businesses and households, due to the substantial growth in capital since the financial crisis. It noted since 2009, the 35 firms have added about $800 billion in common equity capital.
The two scenarios used in the 2018 stress tests feature U.S. and global recessions. In particular, the severely adverse scenario is characterized by a severe global recession in which the U.S. unemployment rate rises by almost 6 percentage points to 10%, accompanied by a global aversion to long-term fixed-income assets. The adverse scenario features a moderate recession in the United States, as well as weakening economic activity across all countries included in the scenario.
“The Board’s stress scenarios assume deliberately stringent and conservative hypothetical economic and financial market conditions,” the Fed said in Thursday’s release. “The results are not forecasts or expected outcomes.”
Results are summarized as follows:
- “Severly adverse” scenario: Aggregate losses at the 35 firms are projected to be $578 billion. This includes losses across loan portfolios, losses from credit impairment on securities held in the firms’ investment portfolios, trading and counterparty credit losses from a global market shock, and other losses. Projected aggregate pre-provision net revenue (PPNR) is $492 billion, and net income before taxes is projected to be −$139 billion.The aggregate Common Equity Tier 1 (CET1) capital ratio would fall from an actual 12.3 percent in the fourth quarter of 2017 to its minimum of 7.9 percent over the planning horizon. The aggregate CET1 ratio is projected to rise to 8.7 percent by the end of the planning horizon.
- “Adverse” scenario: Aggregate projected losses are $333 billion, PPNR is $467 billion, and net income before taxes is projected at $125 billion. The aggregate CET1 capital ratio would fall to its minimum of 10.9 percent over the planning horizon.
“Several factors affected the post-stress capital ratios this year,” the Fed stated. “Credit card balances are generally higher, producing increased losses under stress, totaling $113 billion this year. Additionally, recent changes to the tax code affected the firms and the effects were different across the firms. Several firms had immediate, one-time declines in their starting capital ratios because of certain accounting consequences of the tax changes. The tax law also eliminated some beneficial tax treatments that tended to raise post-tax income in times of stress.”
The Dodd-Frank Act stress tests are one component of the Federal Reserve’s analysis during the Comprehensive Capital Analysis and Review (CCAR), which is an annual exercise to evaluate the capital planning processes and capital adequacy of large bank holding companies.
The Fed notes that banks with less than $100 billion in consolidated assets are no longer subject to Dodd-Frank Act stress tests or CCAR due to changes in the recently enacted regulatory relief statute.
CCAR results will be released June 28 at 4:30 p.m. ET.