U.S. banks ready for severe recession, stress test finds

The large U.S. banks have enough capital to weather a severe recession without withdrawing the supply of credit to the economy, according to the U.S. Federal Reserve Board.

The Fed released the results of the latest annual bank stress tests, which found that even as banks face total projected losses of US$612 billion in a severe recession scenario, their capital levels would remain well above regulatory minimums.

“Under stress, the aggregate common equity capital ratio — which provides a cushion against losses — is projected to decline by 2.7 percentage points to a minimum of 9.7%, which is still more than double the minimum requirement,” the Fed noted.

The ability of the banks to absorb these losses and continue to meet their capital requirements is largely “due to the substantial buildup of capital” since the 2008 financial crisis, the Fed said.

The hypothetical scenario that was used in this year’s stress test — which is tougher than the 2021 test — includes a “severe global recession,” accompanied by a jump in the jobless rate to 10% (which would be an increase of 5.75 points from current levels), along with a 40% decline in commercial real estate prices and a 55% drop in stock prices.

In such a scenario, projected loan losses amount to more than US$450 billion, along with US$100 billion in trading and counterparty losses, plus additional securities and loan losses.

“This year, larger banks saw an increase of over US$50 billion in losses compared to the 2021 test,” the Fed noted. “Additionally, the aggregate 2.7% decline in capital is slightly larger than the 2.4% decline from last year’s test but is comparable to recent years.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.