In a recent report issued on June 28, the American central bank announced that all 23 of the country’s largest banks have passed the “stress tests” and would be able to withstand a severe recession. However, the report also highlighted some weaknesses among midsize and regional banks in the US, although they were not required to participate in the stress testing process.
Following the banking crisis earlier this year, Federal Reserve policymakers hinted at the possibility of making stress testing more challenging in the future. Fed vice-chair for supervision, Michael Barr, emphasized the need to remain vigilant and ensure that banks are resilient to various economic scenarios and market shocks.
“We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.”
The tradition of conducting bank stress tests annually has been in place since the 2008 financial crisis, which was primarily caused by U.S. banks. The purpose of these tests is to assess potential losses in the banking industry if there were to be a significant rise in unemployment and a severe contraction in economic activity.
This year’s stress test by the Fed examined a severe global recession scenario, resulting in a 40% decline in commercial property prices and a 38% decline in home property prices. In the worst-case scenario, unemployment would reach 10%, while the current unemployment rate stands at 3.7%.
US ‘stress test’
According to the stress tests, the 23 largest banks would collectively incur losses of $541 billion in this hypothetical scenario. The Fed has set a stressed capital ratio of at least 4.5% as the benchmark for a passing grade, as capital ratios serve as a crucial measure of a bank’s financial strength.
Earlier this year, the American banking system experienced a significant upheaval with the collapse of several high-profile banks, including Silicon Valley Bank, Signature Bank, Silvergate Bank, and First Republic Bank. Other banks such as PacWest and Western Alliance were also facing instability.
To address these challenges, the Federal Reserve established the Bank Term Funding Program (BTFP) in March, actively providing bailout assistance to smaller banks. The data from the Federal Reserve indicates that over $100 billion has already been allocated to support struggling small and mid-sized banks.
While the stress tests have shown that the largest banks in the United States are well-prepared to endure a severe recession, there remain concerns regarding the resilience of midsize and regional banks. The Federal Reserve acknowledges the need to continue working towards ensuring that banks can withstand a range of economic challenges, market shocks, and other stresses that may arise in the future
