The US Federal Reserve, through “stress tests” on banks, has determined that all 23 of the country’s largest financial institutions will be able to survive a severe recession. The report, published on June 28, also showed relative weakness among medium and regional banks. However, the stress test required the participation of only 23 banks, which are the country’s largest creditors.
In light of the banking crisis earlier this year, Fed policymakers hinted that stress testing could be more difficult going forward. Fed Vice Chairman for Supervision Michael Barr commented: “We must remain modest about how risks may arise and continue our work to ensure banks are resilient to a range of economic scenarios, market turmoil and other stresses.”
Bank stress tests have been conducted every year since the 2008 financial crisis, which was triggered by US banks. The Fed is testing how bad the banking sector’s losses will be if unemployment rises sharply and economic activity falls sharply. In a stress test this year, the Fed tested a severe global recession scenario that caused commercial and residential property prices to decline by 40% and 38%, respectively. In the worst case, unemployment will reach 10% – now it is 3.7%. According to tests, in this scenario, the 23 largest banks would have suffered a combined loss of $541 billion.
According to the Fed, a bank must have a stressed capital ratio of at least 4.5% to qualify. Capital ratios are a key indicator of a bank’s financial strength. Earlier this year, the US banking system was rocked by several high-profile collapses, including Silicon Valley Bank, Signature Bank, Silvergate Bank and First Republic Bank. Others, including PacWest and Western Alliance, found themselves in a precarious position. The Fed has been active in helping smaller banks this year through its Term Bank Financing Facility (BTFP), launched in March. More than $100 billion has already been spent to support small and medium-sized banks, according to the Federal Reserve.