Lending would continue even in severe global recession, Fed stress test finds

The test found that the bank holding companies are strongly capitalized

By Francis Monfort

26 Jun 2018

Households and businesses can continue borrowing even during a severe global recession given the strong capitalization at the largest bank holding companies in the US, according to the results of stress tests released by the Federal Reserve Board.

The Fed’s stress test covered 35 participating firms that represent about 80% of the assets of all banks operating in the US.

"Despite a tough scenario and other factors that affected this year's test, the capital levels of the firms after the hypothetical severe global recession are higher than the actual capital levels of large banks in the years leading up to the most recent recession," Fed Vice Chairman Randal Quarles said.

Under the test’s hypothetical stress scenario, there would be a decline in the firms' aggregate common equity tier 1 capital ratio to a minimum 7.9% level from the actual 12.3% in the fourth quarter. The ratio compares high-quality capital to risk-weighted assets. The Fed found that the covered firms have added about $800 billion in common equity capital since 2009.

The Fed’s most severe scenario projected $578 billion in total losses for the participating firms during nine quarters tested. The "severely adverse" scenario features a six-percentage-point increase in the US unemployment rate to 10% and a steepening Treasury yield curve amid a severe global recession.

The Fed noted that post-stress capital ratios were affected by several factors, including generally higher credit card balances as well as recent changes to the tax code. Under a stress scenario, banks would lose a total of $113 billion in 2018 due to the level of credit card balances. Meanwhile, tax reform had lowered starting capital ratios for a number of firms due to an immediate, one-time change.