The Federal Reserve confirmed on Wednesday that the United States’ largest banks are equipped to endure a significant economic downturn, maintaining the essential function of providing credit to individuals and businesses.
In the annual test of financial resilience, all 31 institutions were able to endure financial distress while keeping capital reserves above the federally mandated minimums, according to the Federal Reserve’s announcement.
The hypothetical adverse conditions included in the stress test involved a jump in unemployment rates to 10%, a sharp 40% decrease in commercial property values, and a steep 36% drop in residential real estate prices.
“The results from the test this year indicate that in the face of our hypothesized stressful scenario, major banks would experience close to $685 billion in total fictional losses and still retain considerably higher capital than the baseline equity requirements,” Michael Barr, the Federal Reserve’s vice chair for supervision, stated. He highlighted the positive impact of the increased capital reserves banks have accumulated over recent years.
The Federal Reserve’s annual stress test acts as a checkpoint to ensure banks hold sufficient financial buffers against potential loan losses and it also informs restrictions on dividend payouts and stock buybacks. Included in this year’s scrutiny were leading financial entities such as JPMorgan Chase and Goldman Sachs, credit services like American Express, and regional banking players such as Truist.
Despite the fact that no bank faltered significantly in the current year’s test, which shared similar parameters to last year’s, the collective capital buffer of the banks experienced a 2.8 percentage point reduction, indicating a slight deterioration from the previous year’s performance.
This downturn is attributed to the banks possessing a larger number of consumer credit card debts and holding corporate bonds that have been subject to downgrades. Furthermore, lending profitability has endured pressure, intensifying compared to last year, reported the Fed.
“Even though banks are in a good position to cope with the particular recessionary scenario we put them against, the stress test has also highlighted certain areas that need monitoring,” Barr commented. He pointed out the continuous change in financial system risks, reflecting on the costly lessons of the previous Great Recession due to unacknowledged risks.
An additional “exploratory analysis” was conducted by the Fed, focusing on potential liquidity stresses and market disruptions, applicable mainly to the eight largest banking institutions.
This separate assessment depicted a scenario in which the banks managed to remain stable, despite an abrupt rise in deposit costs occurring simultaneously with an economic downturn. In a hypothetical case of collapse among five significant hedge funds, the largest banks would incur losses in the range of $70 billion to $85 billion.
“These findings have proven that while there are substantial hedge fund-related exposures, these banks have the capacity to absorb the shock of various disturbances impacting their trading operations,” the Fed revealed.
It is anticipated that the banks will announce their new share buyback strategies this Friday.
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