Large banks pass Fed’s annual stress test

The biggest U.S. banks are favorably situated to manage a major recession and keep above minimum capital requirements, according to the results of the Federal Reserve Board’s annual bank stress test.

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The annual test, one tool to help ensure that large banks can support the economy during downturns, also showed that big banks would experience greater losses than last year’s test.

“While the severity of this year’s stress test is similar to last year’s, the test resulted in higher losses because bank balance sheets are somewhat riskier and expenses are higher,” Vice Chair for Supervision Michael Barr said on June 26. “The goal of our test is to help to ensure that banks have enough capital to absorb losses in a highly stressful scenario. This test shows that they do.”

Using data as of the end of last year, the test evaluates the strength of the banks by estimating their capital levels, losses, revenue and expenses under a hypothetical recession and financial market shock.

All 31 banks tested remained above their minimum common equity tier 1 (CET1) capital requirements during the hypothetical recession after absorbing total projected hypothetical losses of nearly $685 billion, the Fed said. The aggregate CET1 capital ratio, which provides a cushion against losses, is projected to decline by 2.8 percentage points, from 12.7 percent to 9.9 percent. The Fed stated that while that was a greater decline than last year’s, it is within the range of recent stress tests.

The Fed cited several factors that explain the larger capital decline in this year’s test, including increases in banks’ credit card balances combined with higher delinquency rates that have resulted in greater projected credit card losses. In addition, banks’ corporate credit portfolios have become riskier, resulting in higher projected corporate losses, higher expenses, and lower fee income in recent years, resulting in less projected income to offset losses.