© Reuters. FILE PHOTO: A street sign for Wall Street is seen outside the New York Stock Exchange (NYSE) in New York City, New York, U.S., July 19, 2021. REUTERS/Andrew Kelly//File Photo
By Michelle Price
WASHINGTON (Reuters) – The U.S. Federal Reserve on Thursday released scenarios for its annual bank health checks which will assess how well 32 large lenders would fare under a severe economic shock, including a U.S. jobless rate of 10% and a collapse of real estate prices.
The Fed’s annual “stress tests,” introduced following the 2007-2009 financial crisis, dictate how much capital banks need to be healthy and how much they can return to shareholders via share buybacks and dividends.
This year’s tests will attract heightened scrutiny from investors, analysts and regulators following the failure of three banks last year, and as big banks are fighting the Fed over proposed new capital hikes that they say are excessive.
The tests also come amid growing worries over lenders’ exposure to commercial real estate (CRE) after New York Community Bank last month reported losses on soured CRE loans, sparking a sharp fall in its shares.
The CRE sector has faced the twin challenges of financing difficulties amid high interest rates and lower office occupancy due to widespread adoption of remote work.
Overall, this year’s most severe scenario is broadly in line with last year’s. It includes a 36% decline in house prices, compared with 38% in the 2023 scenario, and a 40% decline in commercial real estate prices, the same as last year’s scenario. It also includes a nearly 6.5 percentage-point increase in the U.S. unemployment rate, peaking at 10%, in line with last year.
The 23 banks tested last year sailed through the exam, showing they would suffer a combined $541 billion in losses under the Fed’s severe downturn scenario but would still have over twice the amount of capital required.
Big banks have argued the tests show they are awash with cash, and that capital hikes envisaged by the Fed’s “Basel Endgame” proposal unveiled last year are unwarranted.
“The nation’s largest banks … are strong, highly capitalized, and an important source of support to American households and businesses, even in the face of significant economic headwinds,” said Kevin Fromer, CEO of the Financial Services Forum, a Washington group that represents the CEOs of the largest eight U.S. banks, in response to the test scenarios.
This year’s test will also for the first time include an additional “exploratory analysis” of the banking system, which will test lenders’ resilience to a wider range of risks than the traditional tests. The exploratory analysis will not affect capital, the Fed said.
It will include funding stresses that cause a rapid repricing of a large proportion of deposits at large banks, similar to the stress experienced by banks in March 2023. The largest and most complex banks will also be tested against a scenario in which five large hedge funds fail, the Fed said.
The Fed said it will publish aggregate stress test results in June 2024
(This story has been refiled to add the word ‘nearly’ before 6.5 percentage point in paragraph 6)
