Fed’s Annual Stress Tests to Assume Massive Joblessness, Commercial Real Estate Crash
(Bloomberg) — The largest US banks will be tested against a hypothetical massive surge in unemployment and a crash in commercial real estate in the Federal Reserve’s annual stress tests, according to the scenarios announced Thursday.
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The central bank is examining the ability of the 34 biggest lenders in the US to weather crisis conditions without degrading their capital to dangerous levels. This year’s tests will focus on an employment crisis that sends the jobless rate to more than 10% for at least two years, plus a 40% drop in commercial real estate prices. Additional elements in the mock crisis would include widening corporate bond spreads, a general collapse in asset prices and much higher market volatility.
The results of the 2022 exams will be a key factor affecting the ability of Wall Street giants including JPMorgan Chase & Co., Citigroup Inc. and Goldman Sachs Group Inc. to issue dividends and buy back their stock. The tests’ outcomes — generally released in late June — will decide the day-to-day capital minimum each lender must stay above, so an unexpectedly high or low score can shift capital plans by billions of dollars.
In the Fed’s “severely adverse” scenario, “the economic downturn is amplified by the prolonged continuation of remote work, which leads to larger commercial real estate price declines that, in turn, spill over to the corporate sector and affect investor sentiment,” the central bank wrote, adding that it isn’t predicting such a situation. The hypothetical turmoil would also include trouble in other nations’ financial health “partly driven by building risks in the Chinese economy.”
The testing was put in place after the 2008 financial crisis to ensure the US banking system could withstand the next crisis. While the early years were painful for the banks, and often saw failing marks by prominent institutions, the exercise has become easier for the industry in recent years. Regulators appointed during Donald Trump’s presidency had also relaxed some of the rules, though bankers routinely complained that the exams make unrealistic assumptions and are overly opaque.
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The high-stakes annual process is typically marshaled by the Fed’s vice chair for supervision. While that seat is currently vacant, President Joe Biden has nominated former Fed governor and Treasury official Sarah Bloom Raskin to fill it.
(Updates with test details starting in third paragraph.)
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