The Fed’s annual “stress tests,” introduced following the 2007-to-2009 financial crisis, dictate how much capital banks need to be healthy and how much they can return to shareholders via share buybacks and dividends.
This year’s tests will attract heightened scrutiny from investors, analysts and regulators following the failure of three banks last year, and as big banks are fighting the Fed over proposed new capital hikes that they say are excessive.
The tests also come amid growing worries over lenders’ exposure to commercial real estate (CRE) after New York Community Bank last month reported losses on soured CRE loans, tanking its shares.
The CRE sector has faced the twin challenges of financing difficulties amid high interest rates and lower office occupancy due to widespread adoption of remote work.
This year’s most severe scenario includes a 36 per cent decline in house prices, compared with 38 per cent in the 2023 scenario, and a 40 per cent decline in commercial real estate prices, in line with last year’s scenario. It also includes a 6.5 percentage point increase in the US unemployment rate, peaking at 10 per cent – also in line with last year’s most severe scenario.
Overall, the test is broadly in line with last year’s.
This year’s test will also for the first time include an additional “exploratory analysis” of the banking system, which will test lenders’ resilience to a wider range of risks than the traditional tests. The exploratory analysis will not affect capital, the Fed said.
The exploratory test will include funding stresses that cause a rapid repricing of a large proportion of deposits at large banks, similar to the stress experienced by banks in March 2023. The largest and most complex banks will also be tested against a scenario in which five large hedge funds fail, the Fed said.
The Fed said it will publish aggregate stress test results in June 2024.
REUTERS & BUSINESS STANDARD