The Federal Reserve has completed its
third round of stress tests of American banks.
The tests originated in 2009 in the midst of the financial crisis but
the most recent round was the first of the annual tests now required by the
Dodd-Frank Wall Street Reform and Consumer Protection Act. The tests are designed to estimate the
outcomes that might be experienced by large banks under extremely adverse
economic conditions. The tests are a
tool to help bank supervisors measure whether a bank holds sufficient capital
reserves to support its activities under such conditions and the results are
not forecasts or expected outcomes.
Eighteen bank holding companies (BHCs)
were subjected to a severely adverse stress scenario which presumed a peak unemployment
rate of 12.1 percent, a drop in equity prices of more than 50 percent, a
decline in housing prices of more than 20 percent, and a sharp market shock for
the largest trading firms. Over the nine-quarter planning horizon each
BHC maintains its pre-test common stock dividend payments and common stock
issuance is limited to that associated with expensed employee compensation.
The results suggest that, over the nine
quarters, aggregate losses at the BHCs are suggested to be $462 billion including
losses across loan portfolios, securities held in the BHCs' investment
portfolios, trading and counterparty credit losses from the global market shock,
and other losses.
Projected net revenue before provisions
for loan and lease losses (pre-provision net revenue or PPNR) over the nine
quarters is $268 billion, which is net of losses related to operational-risk
events and mortgage repurchases as well as expenses related to disposition of
owned real estate of $101 billion. Taken
together the high projected losses and low projected PPNR results in projected
net income before taxes of -$194 billion.
These net income projections resulted in
substantial projected declines in regulatory capital ratios for nearly all of
the BHCs under the severely adverse scenario.
The aggregate tier 1 common ratio
would fall from an actual 11.1 percent in the third quarter of 2012 to a
post-stress level of 7.7 percent in the fourth quarter of 2014, including
assumed capital actions for the 18 BHCs.
Despite the large hypothetical declines, the aggregate post-stress capital
ratio exceeds the actual aggregate tier 1 common ratio for the 18 firms of
approximately 5.6 percent at the end of 2008, prior to the first government
stress tests conducted in early 2009
"The stress tests are a tool to gauge the resiliency of the financial
sector," Federal Reserve Governor Daniel K. Tarullo said. "Significant
increases in both the quality and quantity of bank capital during the past four
years help ensure that banks can continue to lend to consumers and businesses,
even in times of economic difficulty."