Will big banks pass the Fed’s 2021 stress test?

The next round of U.S. stress testing for big banks will examine the impact of a severe global downturn, a spike in unemployment and plunging equity markets.

The U.S. Federal Reserve Board has published the hypothetical scenarios that will be used in its 2021 round of bank stress tests, which evaluate the resilience of large banks amid loan losses and the capital impacts of a sharp economic downturn.

This year’s tests will evaluate the effects of a recession that starts in the first quarter, amid a “severe global downturn,” and which features “substantial stress” in commercial real estate and corporate debt markets.

The scenario also includes a 55% plunge in equity prices, amid falling GDP and rising unemployment.

“Banks with large trading operations will be tested against a global market shock component that stresses their trading, private equity, and other fair value positions,” the Fed noted. “Additionally, banks with substantial trading or processing operations will be tested against the default of their largest counterparty.”

“The banking sector has provided critical support to the economic recovery over the past year. Although uncertainty remains, this stress test will give the public additional information on its resilience,” said the Fed’s vice chair for supervision, Randal Quarles, in a release.

Last year, the Fed found that, “large banks were generally well capitalized under a range of hypothetical events but due to continuing economic uncertainty placed restrictions on bank payouts to preserve the strength of the banking sector.”

The Fed’s stress tests are carried out annually for the largest banks, while smaller banks are tested every two years but can opt in to this year’s test.

Among Canadian banks, only TD Group US Holdings LLC is required to participate in the 2021 test. BMO Financial Corp. and RBC US Group Holdings LLC are eligible to opt in.

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.