Testing the mettle: banks to undergo arduous stress tests by Federal Reserve


Elizabeth McLaughlin, Staff


The Federal Reserve is subjecting large banks to routine stress tests in order to measure their ability to cope with a worsening recession.

On Friday, Feb. 12, the Federal Reserve Board released scenarios for its 2021 bank stress tests. The tests are designed to measure the resilience of large banks by estimating their loan losses and capital levels. Last year, banks performed relatively well under the stress tests, and the Fed ultimately placed restrictions on bank payouts to preserve the strength of the banking sector. Large banks are subject to the stress test and some smaller banks have the option to opt-in to the test over a longer period of time. The banks that are required to take part in the upcoming stress test are Capital One Financial (COF), Citigroup (NYSE:C), Credit Suisse (NYSE:CS) Holdings USA, DB USA (NYSE:DB), Goldman Sachs (NYSE:GS), HSBC (NYSE:HSBC) North America Holdings, JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), Northern Trust (NASDAQ:NTRS), PNC Financial (NYSE:PNC), State Street (NYSE:STT), TD Group (NYSE:TD) US Holdings, Truist Financial (NYSE:TFC), UBS Americas (NYSE:UBS), U.S. Bancorp (NYSE:USB) and Wells Fargo (WFC). This upcoming test will be the third stress test in the last 12 months.

The test comes in two parts. The first is the Dodd-Frank Act Stress Test, which analyzes a bank’s balance sheet performance under hypothetical scenarios using a standard capital management plan. The second part is the Comprehensive Capital Analysis and review, which subjects the bank to the same hypothetical scenario, but this time, under their own capital management plan. The test lasts nine consecutive quarters.

The hypothetical recession scenario begins in the first quarter of 2021 and places significant strains on commercial real estate and corporate debt. There will be a severe commercial real estate price decline in this stress test compared to the past three tests. There is also a global market shock component that evaluates banks’ abilities to trade under pressure. Moreover, the unemployment rate will rise by four percent, reaching a peak of 10.75 percent in Q3 2022. This year, the stress test is more severe than usual, given the COVID-19 pandemic and its harrowing effects on the economy. The 2020 stress tests featured a decline in GDP by 9.9 percent and 5.9 percent, as well as peak unemployment rates of 10.0 percent and 12.5 percent. The results of the stress test will be announced by the Federal Reserve on their website by June 30.