Federal authorities unveil potential crisis situations for the year 2025 in their stress tests
The Federal Reserve has unveiled its annual stress test scenarios for large banks, introducing a more rigorous approach that reflects the central bank's growing concern about inflation and recession risks.
This year, 22 banks will undergo the stress tests, compared to 32 last year. The new elements in the exploratory analysis include testing bank resilience to non-bank financial sector shocks during severe recession and a market shock applied to only the largest and most complex banks, hypothesising the failure of five large hedge funds.
The stress test scenarios for 2022 incorporate more severe recession projections, considering persistent inflation and tighter monetary policy effects. The housing market values are expected to experience sharper declines than in prior exercises, reflecting real estate market vulnerabilities.
There's also increased inflation uncertainty, with scenarios stressing banks' resilience to rising prices and associated economic tightening. The focus has shifted towards prolonged economic downturns and global financial stresses, simulating deeper and more sustained adverse conditions.
The banks being tested this year include American Express, Bank of America, BNY, Barclays US, BMO, Capital One, Charles Schwab, Citi., DB USA Corporation, Goldman Sachs, JPMorgan Chase, M&T Bank, Morgan Stanley, Northern Trust, PNC, RBC US Group Holdings, State Street, TD Group US Holdings, Truist, UBS Americas Holding, U.S. Bank, and Wells Fargo.
Banks with major trading operations face additional stress tests that involve global market shock testing for trading positions and the largest counterparty default testing for banks with substantial trading and custodial operations.
The Fed will open a public comment process on its changes to the stress test, inviting feedback from analysts, banks, and the public. The international section of the stress test considers recession in four countries or country blocs, with Japan and developing Asia experiencing deflation.
The stress test includes severe global recession scenarios with added stress in commercial, residential real estate, and corporate debt markets. Analysts at Keefe, Bruyette & Woods believe that the 2025 assumptions are less stressful than recent tests with lower market declines, lower [market volatility index], and lower changes in unemployment, residential, and commercial mortgage indexes.
The ABA has advocated for increased transparency in the Federal Reserve's stress testing program since December, following the lawsuit filed by the American Bankers Association, the Bank Policy Institute, the Ohio Chamber of Commerce, the Ohio Bankers League, and the Chamber of Commerce of the United States of America against the Fed's board of governors in U.S. District Court for the Southern District of Ohio. The lawsuit alleges the central bank's stress testing framework violates the Administrative Procedure Act.
Rob Nichols, president and CEO of ABA, suggested that the Fed should publish the supervisory models and stress scenarios and invite public comment. He stated that the opaque nature of the tests undermines their value for providing meaningful insights into bank resilience.
The goal of these updated and more stringent 2022 scenarios is to ensure banks remain well-capitalized under tougher economic environments, especially given the ongoing inflationary environment and potential for sharper economic slowdowns.
In summary, the 2022 Federal Reserve stress test scenarios feature more rigorous and inflation-sensitive economic downturn assumptions compared to prior years, reflecting the Fed’s increasing concern about persistent inflation, monetary tightening effects, and recession vulnerability.
The stress test scenarios for 2022 in the Federal Reserve's stress test reflect the growing concern about inflation and recession risks in both the business sector and general-news, as they involve more severe recession projections and increased inflation uncertainty. The banks undergoing the stress tests, including major players like JPMorgan Chase, Goldman Sachs, and Morgan Stanley, face additional tests related to their trading operations and global market shocks.
