On Friday, the Fed published hypothetical scenarios for the 2021 bank stress tests. Last year, the Board found that large banks are generally well capitalized under a series of hypothetical events, but have imposed restrictions on bank payments to maintain the strength of the banking sector due to continued economic uncertainty. The Fed’s stress tests are arranged to help large banks lend to households and businesses even in a severe recession. The exercise assesses the resilience of major banks by estimating loan losses and capital levels that provide a buffer against losses under hypothetical recession scenarios extending into the nine-quarter future.
The stress test scenario applied by the Fed to banks is as follows: The hypothetical recession starts in the first quarter of 2021 and there is a serious global decline with significant stress in commercial real estate and corporate debt markets. The unemployment rate in the USA’s “severely unfavorable” scenario reaches a peak in the third quarter of 2022, increasing 4 points from its starting point. Gross domestic product is falling 4 percent from the fourth quarter of 2020. Until the third quarter of 2022, there is a 55 percent drop in stock prices.
This year, 19 major banks will be subjected to stress tests. Smaller banks will be on a two-year stress test cycle, but they can choose this year’s test by April 5th. In addition, banks with significant trading or processing operations will be tested against default by their largest counterparties. These stress test scenarios are not predictions. It includes hypothetical situations to test banks’ capital buffers and lending power against the worst-case scenario. Each scenario includes 28 variables covering domestic and international economic activity.
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