Fed unveils stress tests for US banks to observe in 2016

Central bank outlines three scenarios to ensure that financial institutions are prepared for economic ‘shocks’

More than 30 bank holding companies with total consolidated assets of $50bn have received instructions from the US Federal Reserve on the stress tests they must factor into their operations this year, to ensure they can withstand financial ‘shocks’ and continue to lend to households and businesses.

The three tests, which fall into ‘severely adverse’, ‘adverse’ and ‘baseline’ categories, and each contain 28 variables, are required under both Dodd-Frank and Comprehensive Capital Analysis and Review (CCAR) legislation.

Under Dodd-Frank, banking organisations must implement stress tests as forward-looking tools to help them assess whether they have sufficient capital – on the basis that strong capital positions can absorb losses and help ensure that institutions are able to lend even at times of strain or crisis.

CCAR, meanwhile, sets similar provisions for evaluating capital planning and adequacy among the largest US bank holding companies, accounting for relevant, forthcoming actions such as dividend payments and share issuances or buybacks.

As announced by the Reserve, the three stress tests for 2016 are:

1. Severely adverse A chronic global recession, in which the US unemployment rate rises by 5% to the 10% mark, accompanied by a heightened period of corporate financial stress and negative yields for short-term US Treasury securities;
2. Adverse A moderate recession and mild deflation in the US, plus weakening activity in a number of other key economies; and
3. Baseline A moderate economic expansion, with the unemployment rate gradually declining to 4.5% by the middle of 2017.

With both a domestic and international focus, the variables included in each scenario include factors such as gross domestic product, unemployment, stock market prices and interest rates. In addition to the stress tests and variables, the Board has published a guideline narrative that describes the general economic conditions at play in each test, together with details on how the scenarios have changed compared to those used in 2015.

As in previous years, six bank holding companies with large trading operations will be required to factor a global market ‘shock’ into each scenario. A further eight institutions with significant trading or processing operations must also incorporate a counterparty default scenario.

Federal Reserve governor Daniel K Tarullo said: “In adjusting the scenarios for our yearly stress-testing programme, we strive to assess the resilience of the nation’s largest banks in a variety of potential adverse environments. It is important that the tests are not too predictable from year to year.”

The Reserve has pointed out that none of the three scenarios outlined in the stress tests should be interpreted as forecasts.

For in-depth details on the scenarios, download this Federal Reserve document.