Source: Wise Finance Author: Zhuang Lijia
The Federal Reserve will announce the results of the annual bank stress test after post-market trading on Wednesday Eastern Time. Since the high interest rates of the Federal Reserve have brought significant pressure to banks, this report may receive special attention from the market. If the test results show a higher proportion of banks meeting the standards, it may cause concerns about the Federal Reserve delaying interest rate cuts; if the test results show a large proportion of banks facing risks, it may trigger predictions that the Federal Reserve will cut interest rates as soon as possible.
Why does the Federal Reserve conduct stress tests on banks?
US bank stress tests were born after the 2008 financial crisis to test banks' capital levels and ability to withstand risks. In the test, the balance sheets of large banks will be put to a severe test in a hypothetical economic recession. The test results determine the required capital for banks to maintain healthy operations, as well as the capital that banks can return to shareholders through share buyback and dividends. Normally, the Federal Reserve does not allow banks to announce their dividend and share buyback plans a few days after the results of the stress test are announced.
How is it evaluated?
The annual bank stress test evaluates whether banks can maintain a minimum capital adequacy ratio of 4.5% or higher during a hypothetical economic recession. Banks with strong performance usually have higher capital adequacy ratios than this requirement. In addition, several of the largest global banks in the United States must also meet an additional 1% capital regulatory requirement (G-SIB surcharge).
The test results will help determine the so-called stress test capital buffer for each bank. This refers to the common stock Tier 1 capital (CET1) that banks must hold above the minimum regulatory requirements, in a certain proportion to the risk-weighted assets. The Federal Reserve will announce the stress test capital buffer size for each bank in the months following the announcement of the test results.
The performance of several of the largest banks in the United States, especially JPMorgan, Citigroup, Wells Fargo & Co, Bank of America, Goldman Sachs and Morgan Stanley, will be closely watched.
The Federal Reserve will disclose the overall losses of the tested banks under its assumed testing scenario, as well as the performance of each bank and specific investment portfolio, such as credit cards or mortgages. The Federal Reserve adjusts the testing scenario every year. Last year's stress testing scenario included peak unemployment of 10%, a 40% drop in commercial real estate prices, a 38% drop in house prices, and a short-term interest rate drop to almost zero. This year's scenario is essentially the same as last year.
In last year's stress tests, commercial real estate was a focus. In the hypothetical scenario, properties such as office buildings would suffer losses at a rate of about three times the level seen during the 2008 financial crisis. Although large banks will suffer severe losses under the hypothetical conditions, they can still continue to lend.
In addition, banks with significant trading businesses will face the testing scenario of "global market shock", with some banks also facing the testing scenario of their largest trading counterparties' bankruptcy. This year's test will also include additional exploratory economic and market shocks, which will not help establish capital requirements but will help the Federal Reserve measure whether it should expand testing in the future. Market shocks will apply to the largest banks, and all 32 banks will be subject to economic shocks testing. Michael Barr, Vice Chairman of the Federal Reserve, responsible for supervision, has said that various situations can better identify the weaknesses of banks through testing.
Which banks have taken the test?
In 2024, 32 banks took the stress test, higher than 23 last year. This is because in 2019, the Federal Reserve decided to allow banks with assets between $100 billion and $250 billion to be tested every other year.
The 32 banks that underwent stress tests include: Ally Financial, American Express, Bank of America, Bank of New York Mellon, Barclays Bank, Bank of Montreal, Capital One Financial, Charles Schwab, Citigroup, Citizens Financial, UBS Group (US), Deutsche Bank (US), Discover Financial Services, Fifth Third Bancorp, Goldman Sachs, HSBC North America Holdings, Huntington Bancshares, JPMorgan, KeyCorp, M&T Bank, Morgan Stanley, Northern Trust, PNC Financial Services, RBC USA Group Holdings, Regions Financial, Santander Holdings (US), State Street Bank, TD Bank US Holdings, Truist Financial, UBS Americas Holdings, UBS, Wells Fargo & Co.
Editor/Lambor