Raise your hand if you think banks are as sound as the Fed says they are.
Stress Test Results
Please consider the 2024 Federal Reserve Stress Test Results
This year’s hypothetical scenario is broadly comparable to last year’s scenario. It includes a severe global recession with a 40 percent decline in commercial real estate prices, a substantial increase in office vacancies, and a 36 percent decline in house prices. The unemployment rate rises nearly 6-1/2 percentage points to a peak of 10 percent, and economic output declines commensurately.
The 2024 stress test shows that the 31 large banks subject to the test this year have sufficient capital to absorb nearly $685 billion in losses and continue lending to households and businesses under stressful conditions.
The two funding stresses include a rapid repricing of deposits, combined with a more severe and less severe recession. Under each element, large banks would remain above minimum capital requirements in aggregate, with capital ratio declines of 2.7 percentage points and 1.1 percentage points, respectively.
Under the two trading book stresses, which included the failure of five large hedge funds under different market conditions, the largest and most complex banks are projected to lose between $70 billion and $85 billion. The results demonstrated that these banks have material exposure to hedge funds but that they can withstand different types of trading book shocks.
Stress Test Variables
Participating Banks
There is much more in the report so it’s worth a closer look.
Is the Stress Test All That tough?
Returning to the stress test, some items look extreme, others downright loose.
Note the 3-month interest rates parameters from 5.3 percent to zero percent. What happens in stagflation if the 3-month rate goes to 11 percent?
Another easy parameter is a stock market decline of 55 percent. What if it’s 75 percent? And 75 percent is not all that unusual.
Is a BBB-bond spread of 5.8 percentage points all that tough? What if junk bonds are blown out of the water?
Even if the biggest 31 banks could miraculously survive, are there 150 or more regional banks that wouldn’t?
Banks Want Looser Regulation
The immediate feedback was just what one might expect.
The Financial Services Forum said Wednesday that the Fed’s stress tests prove that a controversial Basel III endgame proposal to boost capital requirements for banks is not necessary.
“The additional capital requirements in the Basel III Endgame proposal are not justified,” the Bank Policy Institute said. “The nation’s largest banks are well capitalized and are a strong source of support to households and businesses, including during times of stress.”
This is the kind of nothing can go wrong plea you hear at every market turning point.
OK guys, why don’t you mark all of your assets to market right now.
A number of banks including Silicon Valley Bank recently went under in a rising rate environment.
Q: So what did the Fed stress test?
A: A falling rate environment that would bail out any losses on bank treasury holdings giving the banks capital gains.
So, raise your hand if you think banks are as sound as the Fed says they are.