– UPDATE: 2020 stress test results out; share buybacks prohibited, dividends capped for 3rd quarter; see story –
Hypothetical scenarios for 2020 stress test exercises to evaluate the ability of 34 large banks with more than $100 billion in assets to keep lending during a recession were released Thursday by the Federal Reserve Board.
The stress test exercises are meant to ensure that large banks have adequate capital and processes so that they can continue lending to households and businesses, even during a severe recession, the Fed said. The harshest scenario, it noted, includes a severe global recession with heightened stresses in corporate debt markets and commercial real estate, and for banks with large trading operations, additional pressure on leveraged loans.
The Fed Board’s stress test framework includes the Comprehensive Capital Analysis and Review (CCAR) and the Dodd-Frank Act stress tests (DFAST).
Banks have until April 6 to submit their capital plans and the results of their own stress tests to the Federal Reserve, according to the release. The Fed Board will announce results of its supervisory stress tests by June 30, it said.
The stress tests include two hypothetical scenarios: baseline and severely adverse. The severely adverse scenario this year features a severe global recession in which the U.S. unemployment rate rises by 6.5 percentage points to 10%, and elevated stress in corporate debt markets and commercial real estate.
The Fed said banks with large trading operations will be required to factor in a global market shock component as part of their scenarios. This year’s shock features, among other things, heightened stress to trading book exposures to leveraged loans. Firms with substantial trading or processing operations also will be required to incorporate a counterparty default scenario component. Thirteen of the 34 banks involved in this year’s stress testing will have to factor in one or both of these components:
- Bank of America Corporation (must factor in global market shock and counterparty default components)
- The Bank of New York Mellon Corporation (must factor in counterparty default)
- Barclays US LLC (both)
- Citigroup Inc. (both)
- Credit Suisse Holdings (USA) (both)
- Deutsch Bank USA Corporation (both)
- The Goldman Sachs Group, Inc. (both)
- HSBC North America Holdings Inc. (both)
- JPMorgan Chase & Co. (both)
- Morgan Stanley (both)
- State Street Corporation (must factor in counterparty default)
- UBS Americas Holdings LLC (both)
- Wells Fargo & Company (both)
“This year’s stress test will help us evaluate how large banks perform during a severe recession, and give us increased information on how leveraged loans and collateralized loan obligations may respond to a recession,” Vice Chair for Supervision Randal K. Quarles.
The Fed noted that the severely adverse scenario and baseline scenarios are not forecasts. The severely adverse scenario describes a hypothetical set of events designed to assess the strength of banking organizations. Similarly, the baseline scenario is in line with average projections from surveys of economic forecasters. Each scenario includes 28 variables – such as gross domestic product, the unemployment rate, stock market prices, and interest rates – covering domestic and international economic activity.
“As previously stated, the Board continues to work toward having the stress capital buffer in place for this year’s stress tests,” the Fed said. “The release of the hypothetical scenarios does not affect that separate rulemaking process.”