On June 26, 2024, the Federal Reserve Board of United States (hereinafter referred to as the Federal Reserve) released the results of stress tests for more than 30 large banks in United States in 2024. Bank stress test results show that large banks are well positioned to weather a severe recession and stay above minimum capital requirements, despite the fact that they will suffer greater losses than last year in a "severe adverse scenario". In addition, the Fed also published the aggregate results of its first exploratory analysis, which will not affect bank capital requirements

“This year's stress test shows that large banks have sufficient capital to withstand high levels of stress and meet their minimum capital ratios,” said Michael S. Barr, Vice Chairman of Supervision at the Federal Reserve. “Although the severity of this year's stress test is similar to last year's, the test resulted in higher losses due to greater risks and costs on bank balance sheets. Our goal with these tests is to help ensure that banks have enough capital to absorb losses under severely stressful conditions. This test shows that they do indeed have sufficient capital.
The Federal Reserve's stress test is a tool to help ensure that large banks can continue to support the economy during an economic downturn. The test uses bank data as of the end of last year to assess the financial resilience of large banks by estimating their capital levels, losses, income, and expenses under assumed economic recession and financial market shocks. For more detailed information on the Federal Reserve's stress test, please refer to the 'Introduction to the Federal Reserve's Stress Test'.
Individual results of stress tests provide information on the bank's capital requirements, i.e., the Federal Reserve will refer to the results of the stress tests to propose capital adequacy requirements to individual banks, to ensure that banks can survive severe economic recessions and financial market shocks.
During the assumed economic downturn, all 31 tested banks remained above their minimum Common Equity Tier 1 (CET1) capital requirements after absorbing nearly $685 billion in assumed losses. In the 'severely adverse stress scenario', the CET1 total capital ratio is projected to decrease by 2.8 percentage points, from 12.7% to 9.9%. While this is a larger decrease than last year's (which was 2.5%), it is within the recent stress test scope.
The hypothetical scenario for this year is roughly equivalent to last year's. It includes a severe global economic recession, a 40% drop in commercial real estate prices, a significant increase in office vacancy rates, and a 36% decline in house prices. The unemployment rate has risen by nearly 6.5 percentage points, reaching a peak of 10%, and economic output has correspondingly declined. For the stress test scenario parameters in 2024, please refer to the "Federal Reserve's 2024 Annual Stress Test Scenarios (with Stress Parameters Table)"
The pressure scenario parameters for 2024 are very similar to last year. Therefore, the driving force behind the decrease in CET1 is not the change in the scenario parameters, but the long result.
On the contrary, the three main factors that contribute to the decrease in CET1 by 2024 are related to changes in the bank's balance sheet. They are:
1. The large increase in bank credit card balances, coupled with the rise in delinquency rates, has led to an expected increase in credit card losses. Large banks have a significant credit card business, so the changes here could significantly impact stress testing.
2. The risk of the bank's corporate loan portfolio has increased, reflected in the downgrade of loan ratings by individual banks (i.e., credit deterioration), leading to increased expected losses for the enterprises. As shown in the following figure, the proportion of high credit-rated loans has decreased, while the proportion of low-rated loans has risen and the default rate is higher under pressure scenarios.
3. In recent years, the expected net income from offsetting losses has decreased due to an increase in non-interest costs and a decrease in non-interest income.
As a complementary tool for the 2024 regulatory stress testing, the Federal Reserve also conducted an exploratory risk analysis, including two funding pressure analyses for all tested banks, and two trading book pressure analyses for only the largest and most complex banks. The results of the exploratory analysis do not affect the Fed's capital requirements for large banks. The four elements considered by the Federal Reserve in the exploratory analysis of the banking system are:
1. In the situation of global mild recession, increased inflationary pressure, and rise in interest rates, funding pressure has led to rapid repricing of large bank deposits;
2. Under severe global economic recession, high inflation, sustained inflation and Intrerest Rate rise, the same funding pressure;
3. Market shocks, characterized by the expectation of reduced global economic activity, lead to sudden market dislocations;
4. Market shock, characterized by a sudden misalignment of financial markets, stemming from expectations of severe recessions in the United States and other countries.
Exploratory analysis is different from stress testing in that it explores other assumed risks in a wider banking system.
These two funding pressures include the rapid repricing of deposits, as well as more severe and less severe economic downturns. Under each pressure element, the capital ratios of large banks will remain above the minimum capital requirements, decreasing by 2.7 and 1.1 percentage points respectively. The changes in the Common Equity Tier 1 (CET1 Ratio) and Pre-provision Net Revenue (PPNR) under the two funding pressure tests.
Under the pressure of two trading books, including the collapse of five large Hedging funds under different market conditions, the largest and most complex banks are expected to lose $70 to $85 billion. The results show that these banks have significant exposures to Hedging funds, but they can withstand different types of trading book shocks.