According to a new Federal Reserve report, the nation’s largest banks all passed the annual Fed stress test. The tests reportedly found that the financial sector remains resilient, though some weaknesses were noted in the Fed’s final report.
The importance of the Fed stress test
The Fed stress test process was initiated in the wake of the 2008 financial crisis. Regulators use the tests to assess major banks’ ability to withstand a variety of hypothetical economic difficulties. The results provide the Federal Reserve with insight into potential weaknesses that could impact the banking sector.
The most recent tests assessed banks’ capacity to withstand a major global recession. The hypothetical scenario assumed a downturn that drove commercial real estate values down by 40%, while also dropping home values by nearly as much. The scenario also hypothesized an unemployment rate of 10%.
This year’s Fed stress test results suggested that the 23 largest firms would all manage to survive the hypothetical scenario. According to the Fed, those banks would lose a combined $541 billion, with a decline in capital ratio from 12.4% to 10.1%. That result was reportedly similar to previous test results. According to an AP report, banks can only pass the test with a stressed capital ratio of 4.5% or greater.
The reported results did show that midsize and super regional banks tended to fare worse than their larger rivals. Those banks had lower stressed capital ratios than the larger banks. That’s largely due to those banks’ struggles during the current high inflation, high interest rate environment.
Fed vice chair for supervision Michael Barr emphasized the importance of the Fed stress test process:
“We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.”