The largest US banks would survive a severe recession, the Fed’s ‘stress tests’ show

The country’s 23 largest banks have passed the Fed’s so-called stress tests this year, a sign that the country’s banking system remains resilient despite the recent banking crisis that led to Silicon Valley bank failure, signature bank And First Republic Bank.

The Fed’s report released on Wednesday showed some relative weakness among mid-sized and “big regional” banks, with some getting a pass score with a smaller-than-usual cushion. These results may surprise investors and policy makers.

Fed policymakers have also hinted that they may make the tests more difficult in future iterations, due to the banking crisis earlier this year.

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“We must remain modest about how risks arise and continue our work to ensure banks are resilient to a range of economic scenarios, market shocks and other stresses,” Michael Barr, the Fed’s vice chair for supervision, said in a statement.

“Stress tests” have become an annual report card for the country’s financial system since they were implemented after the Great Recession and financial crisis of 2008. Tests vary from year to year, but generally involve the Fed testing how severe losses would be in the banking industry if unemployment rose too high and contracted. vigorous economic activity.

The Fed also used current events to determine their scenarios. For example, the central bank previously tested banks against the possibility of a double-dip recession caused by the coronavirus pandemic.

In the 2023 tests, the Fed assumed a scenario in which a severe global recession caused a 40 percent drop in commercial real estate prices and a significant increase in office vacancies, as well as a 38 percent drop in home prices. Under the Fed’s worst-case scenario, the unemployment rate would rise to 10 percent — it’s currently 3.7 percent.

In this scenario, the 23 largest banks would have collective losses of $541 million, and their capital ratios would decline from 12.4 percent to 10.1 percent. The Fed said this is similar to previous years.

A bank must have a tight capital ratio of at least 4.5 percent to be considered for success. The collective average was much higher than this figure.

Also read: Report: High inflation and high borrowing costs affected the financial situation of families

The Fed also tested the balance sheets of banks with large trading books to see if they could withstand the market shock caused by rising inflation and rising interest rates. The results showed that these banks would be able to withstand such a shock.

The banks with the lowest capitalization ratios under these tests were midsize banks, such as M&T Bank and Citizens Bank, and Super Regionals, or banks with a national presence and assets of more than $500 billion, such as US Bancorp and Truist, while investors were not. Worried about these banks as much as their smaller counterparts, it shows how banks that aren’t too big to fail are struggling with high interest rates and inflation.

Under the Fed’s test, US Bank would have 6.6 percent, Trust would be at 6.7 percent and Business Financial would be at 6.4 percent.

The number of 23 banks tested this year is down from 34 in 2022, as the Federal Reserve decided in 2019 to allow banks with between $100 billion and $250 billion in assets to be tested every two years.