The US Federal Reserve Releases New Scenario Stress Tests for Banks
On Thursday 15th March 2024 the Federal Reserve issued new annual scenarios for stress tests for banks which will check their health under extreme economic shocks. These hypothetical shocks will include a collapse of real estate prices (40% drop in commercial real estate prices), and a jobless figure of 10% and will cover 32 banks including some with as little assets as USD100 Billion. Furthermore, the largest and most complex banks will be tested under a scenario where five hedge funds collapse at the same time. These stress scenarios represent the first tests since the collapse of Signature Banks and Silicon Valley in March 2023, which also led to the collapse of Credit Suisse Ag sparking concerns regarding the banking system as a whole.
Interestingly, the Federal Reserve has advised that these hypothetical scenarios will not affect or impact any of the tested banks capital adequacy requirements, pointing out that all results will not be issued until June 2024. These tests were first put in place post 2007 – 2009 Global Financial Crisis to ensure that banks in the United States could withstand further economic shocks and would allow banks to continue to lend to businesses and households despite any on-going shocks. These tests were a result of the Dodd-Frank Act (full name The Dodd-Frank Wall Street Reform and Consumer Protection Act), that was enacted into law on the 21st of July 2010.
These tests are also very timely as there are growing worries in the financial markets regarding the exposure to commercial real estate (CRE), by a number of lenders, indeed, in January 2024 New York Community Bank sparked a drop in their share price having reported losses on bad CRE loans. The CRE sector (data released show small banks account for nearly 75% of outstanding loans in the CRE sector), has been facing a double whammy on the financial front with falling office occupation (due to widespread adoption of remote work) and high interest rates due to the Federal Reserve’s quantitative tightening measures. Interestingly, the 23 banks that were tested last year passed the tests with flying colours showing under the stress test scenarios they would lose a combined USD541 Billion but would still have double the amount of capital required.
In November, the United States will have their Presidential election most likely between Joe Biden (Democratic incumbent), and ex-President Donald Trump (Republican candidate). If Donald Trump is the victor, financial markets should be reminded that under his reign he signed into law a bill that amazingly reduced scrutiny over banks with assets under USD250 Billion, thus removing the requirement for many regional banks to submit stress testing plus reducing the amount of cash on their balance sheet usually required to protect against financial emergencies. If indeed he tries to do this again, we can only hope that insiders and financial authorities can prevail against this sort of action, otherwise we may have another financial disaster on our hands.
