U.S. Federal Reserve to Release Annual Bank Health Check Results
The U.S. Federal Reserve is set to release the results of its annual bank health checks on June 28. Through this “stress test” exercise, the Fed examines banks’ balance sheets against a hypothetical severe economic downturn, with the details changing each year. The outcome determines how much capital banks need for their health and how much can be returned to shareholders via share buybacks and dividends.
Why Does the Fed “Stress Test” Banks?
The formal testing process started in 2011, with major banks, such as Citigroup, Bank of America, and Goldman Sachs, initially having difficulties in passing the tests. These banks had to adjust their capital plans to address the Fed’s concerns. Nowadays, banks have become more proficient at the tests, and the Fed has made the process more transparent by abandoning the “pass-fail” model and implementing a more bank-specific capital regime.
How Are Banks Assessed Now?
Banks are tested on whether they could maintain a required minimum capital ratio of 4.5% during a hypothetical downturn. The largest global banks must also maintain an additional “G-SIB surcharge” of at least 1%. The outcome of the test further dictates the required “stress capital buffer” for the banks on top of the 4.5% minimum. The greater the losses, the larger the buffer.
The Rollout
The Fed typically publishes aggregate industry losses and individual bank losses, including details about specific portfolio performances, like credit cards and mortgages.
A Tougher Test?
The stress tests can risk becoming outdated, as they take months to devise. Nevertheless, the 2023 test is expected to be more challenging than previous tests due to a healthier economic baseline.
Stresses in Commercial Real Estate and Corporate Debt
The stress test also includes a 40% decrease in commercial real estate prices, an area of greater concern amid continuing pandemic-era office vacancies. Additionally, banks with large trading operations will be subject to a “global market shock,” and some will be tested against the failure of their largest counterparty.
Which Firms Are Tested?
In 2023, 23 banks will be stress-tested, down from 34 in 2022, as the Fed decided in 2019 to allow banks with between $100 billion and $250 billion in assets to be tested every other year.