The Federal Reserve Board finalized the hypothetical scenarios for its annual stress test, which is designed to help large banks prepare for a recession or difficult economic conditions.
The final scenarios are similar to the scenarios that were proposed in October. Further, the Fed voted to maintain the current stress capital buffer requirements until 2027.
“Waiting to calculate new stress capital buffer requirements until we receive public feedback will give us the opportunity to correct any deficiencies in our supervisory models based on that feedback,” Fed Vice Chair for Supervision Michelle Bowman said. “This should further improve the transparency, effectiveness, and fairness of our models and improve our accountability to the public.”
The annual stress test evaluates the resilience of large banks by estimating losses, net revenue, and capital levels under hypothetical recession scenarios that extend two years into the future. I(n 2026, 32 banks will be tested against a severe global recession with heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets.
The Fed points out that the scenarios are not forecasts and should not be interpreted as predictions of future economic conditions.
In this particular 2026 stress test scenario, the U.S. unemployment rate rises nearly 5.5 percentage points, to a peak of 10 percent. Also, the unemployment rate increase is accompanied by severe market volatility, a widening of corporate bond spreads, and a collapse in asset prices. This includes about a 30 percent decline in house prices and a 39 percent decline in commercial real estate prices.
Further, large banks with substantial trading or custodial operations are required to incorporate a counterparty default scenario component to estimate potential losses from the unexpected default of the firm’s largest counterparty amid an acute market shock. Also, banks with large trading operations will be tested against a global market shock component that primarily stresses their trading and related positions.
Additionally, the scenarios include two revisions to the global market shock component to improve consistency across shocks applied to similar exposures and enhance plausibility.