On Wednesday, the Federal Reserve affirmed that the largest banks in the United States are prepared to withstand a significant economic downturn while continuing to play their critical role in extending credit to both consumers and businesses.
In its annual assessment of financial resilience, the Federal Reserve reported that all 31 banks examined successfully navigated financial stress while maintaining capital reserves above the federally required minimum levels.
The stress test’s hypothetical adverse scenarios included a spike in unemployment to 10%, a steep 40% fall in commercial property values, and a dramatic 36% decline in residential property prices.
“This year’s test results show that, under our proposed stressful circumstances, major banks would face nearly $685 billion in total hypothetical losses yet still maintain significantly greater capital than the minimum equity requirements,” noted Michael Barr, the Federal Reserve’s vice chair for supervision. He emphasized the benefits stemming from the increased capital reserves that banks have built up over recent years.
The Federal Reserve’s annual stress test serves as a benchmark to ensure that banks maintain adequate financial cushions against potential loan defaults and informs restrictions on dividend payments and stock buybacks. This year’s evaluation included major financial institutions such as JPMorgan Chase and Goldman Sachs, credit service companies like American Express, and regional banks like Truist.
While no banks reported severe shortcomings in this year’s test, which mirrored last year’s parameters, the total capital buffer for the banks saw a 2.8 percentage point decrease, indicating a minor decline from the previous year’s results.
This decline is linked to an increased amount of consumer credit card debt among banks and the ownership of corporate bonds that have faced downgrades. Additionally, lending profitability has faced increased pressure compared to last year, according to the Fed’s report.
“Although banks are in a strong position to manage the specific recessionary scenario we presented, the stress test also underscored certain areas that warrant ongoing oversight,” Barr observed. He reflected on the evolving risks in the financial system, recalling the costly lessons learned during the last Great Recession attributed to unrecognized risks.
The Fed also carried out an additional “exploratory analysis” that examined potential liquidity pressures and market disruptions, focusing mainly on the eight largest banking institutions.
This separate evaluation suggested that these banks could maintain stability even with a sudden rise in deposit costs amid an economic downturn. In a hypothetical situation where five large hedge funds collapsed, the largest banks would sustain losses estimated between $70 billion and $85 billion.
“These findings demonstrate that, despite significant hedge fund-related exposures, these banks are equipped to absorb the shocks from various disruptions affecting their trading activities,” the Fed disclosed.
Banks are expected to announce their new stock buyback plans this Friday.
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