Evening Brief – 06.29.23
The nation’s 23 largest US banks are well capitalized and would be able to withstand a severe recession, according to the Federal Reserve’s annual stress tests released Wednesday after the market close.
According to the Fed results, while banks would lose $65 billion from a 40% drop in the commercial real estate market and $541 billion overall in a severe recession, they would continue to lend even under such conditions.
Under a severely adverse scenario, the aggregate CET1 capital ratio of risk-weighted assets to capital would fall to 10.1% from 12.4%; still enough to meet the minimum capital ratios the banks would need to survive.
Following the 2008 Financial Crisis, banks significantly increased their capital and have maintained them for the past several years, according to the Fed. “The aggregate and individual bank post-stress common equity tier 1 (CET1) capital ratios remain well above the required minimum levels throughout the projection horizon,” the results showed.
The test determines whether banks can sustain a minimum capital ratio of 4.5% in the face of a hypothetical economic disaster. JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley would all have capital buffers more than the Fed’s minimum requirement, as well as mid-sized banks like PNC, Truist and M&T.
Instead of just testing how banks would fare in an adverse scenario, Fed Vice Chair for Supervision Michael Barr also proposed a “reverse stress test,” in which regulators would try to determine what it would take for a bank to fail.
The Fed conducted, in addition to the required stress test, what is known as an “exploratory market shock.” The test subjected the eight US Global Systemically Important Banks (G-SIBs), which are the country’s largest banks, to conditions that were comparable to those that led to the failure of Silicon Valley Bank.
The Fed put them through a series of tests that included a milder economic downturn, rising interest rates, an appreciating dollar, higher commodity prices and high inflation expectations.
One of the concerns heading into this year’s stress tests was that capital requirements for most banks would be growing, adding another headwind to returns and profitability while also raising the likelihood that a specific bank would surpass regulatory capital limits. This year’s test revealed the opposite, giving many banks breathing room as they prepare for forthcoming regulatory changes, with the larger banks bearing the brunt of the burden.
Barr warned, however, the stress tests were “only one way to measure that strength” and said regulators “should remain humble about how risks can arise.”