Fed Stress Test Shows American Banks Can Survive Recessionary Scenario Despite $685 Billion in Losses

The seal of the Federal Reserve Board as its appears outside the Fed's William McChesney Martin Building in Washington, on March 13, 2023. (Alex Wong/Getty Images)

U.S.-based banks suffered losses in a hypothetical economic downturn under the Federal Reserve’s 2024 stress tests, but the banks managed to retain minimum capital requirements, and were “well positioned to weather a severe recession.”

Stress tests are regular analysis conducted to determine whether banks have enough capital to withstand negative economic situations. In this year’s test, the Fed assessed how 31 banks would perform when faced with tough conditions like a severe global recession, a 40 percent decline in commercial real estate, a 36 percent fall in house prices, a substantial fall in office vacancies, and a 10 percent unemployment rate. 

The analysis concluded that the banks would suffer a loss of $685 billion in such a situation, according to a June 26 agency press release. Although this is $144 billion higher than last year’s $541 billion, there were only 23 banks in the test last year. When individual institutional losses are calculated, there was an average loss of $23.5 billion per bank in 2023, compared to $22 billion per bank loss this year.

The test showed that all 31 banks were able to remain above their minimum common equity tier 1 (CET1) capital requirements during the stress-test scenario. CET1 is used in stress tests to measure a bank’s liquidity and its ability to get through challenging financial conditions. Essentially it’s a measure of their cushion to absorb losses.

“This year’s stress test shows that large banks have sufficient capital to withstand a highly stressful scenario and meet their minimum capital ratio,” said Vice Chair for Supervision Michael S. Barr.

“While the severity of this year’s stress test is similar to last year’s, the test resulted in higher losses because bank balance sheets are somewhat riskier and expenses are higher. The goal of our test is to help to ensure that banks have enough capital to absorb losses in a highly stressful scenario. This test shows that they do.”

The CET1 capital ratio, which compares the bank’s capital against risk-weighted assets, declined from 12.7 percent to 9.9 percent. However, the ratio remained within the range of recent stress tests, the Fed noted.

The $685 billion in losses included $175 billion in credit card losses, $142 billion from commercial and industrial loans, and an almost $80 billion loss from commercial real estate.

The results came out as the House Financial Service Committee held a hearing on the stress tests on Wednesday. During the hearing, Rep. Andy Barr (R-Ky.) called for bringing more transparency to such financial analysis.

“Instead of running stress tests in an open and accountable manner, subject to public scrutiny, the Federal Reserve cloaks the stress tests under a veil of secrecy. This is no legal basis for this secrecy, and the perceived benefits of secrecy are illusory at best,” he said.

“And with growing politicization of the federal banking agencies, it is possible that rogue officials pursuing political agendas could also game the tests by manipulating models and assumptions to obtain desired results for heightened capital requirements or reduced dividends,” he said.

Transparency in Stress Tests

The American Bankers Association (ABA), which represents banks accounting for around $19 trillion in deposits, welcomed the Fed’s stress-test results, claiming it shows the country’s banks remain “healthy, highly capitalized, and well prepared to weather a severe recession.”

“The continued strength and resilience of the banking sector is further evidence that the recent tsunami of new regulation, including proposed higher capital standards, is unwarranted and would only hinder the ability of banks of all sizes to serve their customers, clients, and communities.”

In a June 26 post, the Bank Policy Institute pointed out that the Fed’s stress tests consistently show large banks are capitalized well enough to face tough economic situations.

The results of these tests are used to determine capital requirements for banks. If the performance of banks comes out as too uncertain, they could end up allocating capital in an excessively conservative manner. This limits the money lent out by banks to individuals and businesses, the BPI stated.

“Given its far-reaching economic implications, the stress-testing regime deserves public transparency through the notice and comment process, a legal requirement the Fed currently does not meet,” it said.

Francisco Covas, the head of research at BPI, took part in the House Financial Service Committee hearing on Wednesday. He called for allowing public comments on the scenarios and models used by the Fed in the tests.