The US Federal Reserve Board released the results this week of its annual bank stress test, which demonstrates that large US banks are well positioned to weather a severe recession and continue to lend to households and businesses, even during a severe recession, writes David Little, a partner in our Corporate and Commercial Law team.
Following the collapse of five regional banks in the US and Credit Suisse in Europe in the course of the last six months, this is surely heartening news.
“Today’s results confirm that the banking system remains strong and resilient,” Vice Chair for Supervision Michael S. Barr said. “At the same time, this stress test is only one way to measure that strength. 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.”
Regulators’ stress tests are one tool to help ensure that large banks can support their countries’ economies during economic downturns. The tests evaluate the resilience of large banks by estimating their capital levels, losses, revenue and expenses under a single hypothetical recession and financial market shock, using banks’ data as of the end of last year.
In the US all 23 banks tested remained above their minimum capital requirements during the hypothetical recession, despite total projected losses of $541 billion. Under stress, the aggregate common equity risk-based capital ratio – which provides a cushion against losses – was projected to decline by 2.3 percentage points to a minimum of 10.1 percent.
This year’s stress test included a severe global recession with a 40 percent decline in commercial real estate prices, a substantial increase in office vacancies, and a 38 percent decline in house prices. The unemployment rate rises by 6.4 percentage points to a peak of 10 percent and economic output declines commensurately.
The test’s focus on commercial real estate shows that while large banks would experience heavy losses in the hypothetical scenario, they would still be able to continue lending. The banks in this year’s test hold roughly 20 percent of the office and downtown commercial real estate loans held by banks. The large projected decline in commercial real estate prices, combined with the substantial increase in office vacancies, contributes to projected loss rates on office properties that are roughly triple the levels reached during the 2008 financial crisis.
The individual results from the stress test factor directly into a bank’s capital requirements, mandating that each bank must hold enough capital to survive a severe recession and financial market shock.
If a bank does not stay above its capital requirements, it is subject to automatic restrictions on capital distributions and discretionary bonus payments.
You can read the whole of the Fed’s press release here.
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David Little is a Partner at Bishop & Sewell in our expert Corporate & Commercial team. If you would like to contact him, please quote Ref CB405 on either on either 07968 027343 / 020 7631 4141 or email email@example.com.
The above is accurate as at 30 June 2023. The information above may be subject to change.
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.