Fed Announces 2025 Stress Test Scenarios for Banks, Makes It Easier This Year

The Federal Reserve Bank in Washington on Jan. 14, 2025. Madalina Vasiliu/The Epoch Times

The U.S. Federal Reserve announced hypothetical scenarios for the 2025 annual stress tests for banks to analyze how well they fare in adverse economic conditions. The 22 institutions, subject to the test, are slated for a less severe scenario test this year than the prior year.

The Fed’s annual stress tests evaluate the resiliency of large banks in hypothetical recession scenarios. Specifically, they check whether these institutions are sufficiently capitalized to absorb losses when faced with unfavorable conditions while, at the same time, able to meet their obligations. The test helps ensure that large banks are in a position to continue lending to consumers and businesses under severe economic recession. On Feb. 5, the Fed released its hypothetical scenarios for the 2025 annual stress test.

For this year, banks will be tested in scenarios where the U.S. unemployment rate spikes by 5.9 percentage points to hit 10 percent; market volatility becomes severe; corporate bond spreads widen; and asset prices collapse, including a 30 percent fall in commercial real estate prices and a 33 percent dip in house prices.

This is an easier test scenario compared to 2024 in which the unemployment rate jumped by a higher 6.5 percentage point to 10 percent, home prices fell by a larger 36 percent, and commercial real estate prices declined by 40 percent rather than this year’s 30 percent.

The Fed’s decision to use an easier test scenario this year comes after multiple banking and commerce groups filed a lawsuit against the central bank in December, accusing the agency of running opaque stress tests that put financial institutions in a tough spot.

Tom Quaadman, senior vice president of economic policy at the U.S. Chamber of Commerce, one of the plaintiffs in the case, said the current stress test “acts as a regulation and restricts business financing.”

“The stress tests were never submitted to public notice and comment and lacked the transparent administrative due process that rules must be subject to,” he said.

The 2025 test is applicable to 22 banks, down from 31 last year. This year’s test includes Barclays, Citigroup, Bank of America, Capital One, Morgan Stanley, Wells Fargo, UBS, and Goldman Sachs.

The Fed plans to release the stress test results in June.

Stress Tests and Bank Challenges

The Fed’s stress test results are used to determine banks’ capital requirements—the amount of liquid capital they must have on hand. Capital requirements are aimed at ensuring the institutions remain solvent.

Capital requirements influence the way banks allocate capital across their products, such as mortgages and other debts, according to a June 2024 post by advocacy group Bank Policy Institute (BPI).

If banks underperform in the tests, they may allocate capital in an “overly conservative” way to ensure institutional requirements are met. Such conservative allocation can “deprive businesses and consumers of the lending and capital markets intermediation that fuels economic growth,” said the institute.

In a Dec. 24, 2024, post, the institute, a plaintiff in the lawsuit against the Fed, said that the current stress tests produce “arbitrary, counterintuitive and sometimes inaccurate results” each year.

“The lack of transparency and volatility in the results makes it difficult for banks to plan and manage capital effectively, leading to higher borrowing costs for their customers,” it said. “The uncertainty also weakens banks’ market-making and capital markets capacity, hurting a critical financing conduit for U.S. businesses and local governments.

“The capital markets services that the largest U.S. banks provide are essential for economic growth, with 75% of financing for U.S. businesses and government coming from the capital markets.”

On Feb. 5, the Fed said that it plans on taking steps to bring down the volatility of stress test results and will “improve model transparency in the 2025 stress test.”

Previously, on Dec. 23, 2024, the central bank announced it would seek public comments on making “significant changes” to improve test transparency, citing the “evolving legal landscape & changes in the framework of administrative law.”

Comments shall be sought on all the models used to determine revenues and losses of banks subject to the stress tests, among other issues. The agency said that capital “acts as a cushion to absorb losses.”

“Since its inception over 15 years ago, large banks in the stress test have more than doubled their capital levels, an increase of more than $1 trillion,” it said.