The results of supervisory stress tests conducted by the Federal Reserve Board showed the nation’s largest holding banks continue to build their capital levels and improve their credit quality, strengthening their ability to lend to households and businesses during a severe recession.
The most severe hypothetical scenario projects that loan losses at the 33 participating bank holding companies would total $385 billion during the nine quarters tested. The “severely adverse” scenario features a severe global recession with the domestic unemployment rate rising five percentage points, accompanied by a heightened period of financial stress, and negative yields for short-term U.S. Treasury securities.
The firms’ aggregate common equity tier 1 capital ratio, which compares high-quality capital to risk-weighted assets, would fall from an actual 12.3% in the fourth quarter of 2015 to a minimum level of 8.4% in the hypothetical stress scenario. Since 2009, these firms have added more than $700 billion in common equity capital.
“The changes we make in each year’s stress scenarios allow supervisors, investors and the public to assess the resiliency of the banking firms in different adverse economic circumstances,” said Governor Daniel K. Tarullo. “This feature is key to a sound stress testing regime, since the nature of possible future stress episodes is inherently uncertain.”
Capital is important to banking organizations, the financial system, and the economy because it acts as a cushion to absorb losses and helps to ensure that losses are borne by shareholders. The board’s stress scenario estimates use deliberately stringent and conservative assessments under hypothetical economic and financial market conditions. The results are not forecasts or expected outcomes.
This is the sixth round of stress tests led by the Federal Reserve since 2009 and the fourth round required by the Dodd-Frank Act. The 33 firms tested represent more than 80% of domestic banking assets. The Federal Reserve uses its own independent projections of losses and incomes for each firm.
The Fed also released results from the “adverse” scenario, which features a moderate recession and mild deflation in the U.S. In this scenario, the aggregate common equity capital ratio of the 33 firms fell from an actual 12.3% in the fourth quarter of 2015 to a minimum level of 10.5%.