The largest bank holding companies in the U.S. continue to build up capital levels and improve their credit quality, strengthening their ability to lend to households and businesses during a severe recession.
Those were the findings of supervisory stress tests announced June 23 by the Federal Reserve Board.
The stress tests looked at the ability of the banks to withstand a severe global recession, where the domestic unemployment rate would rise by 5 percentage points, accompanied by a heightened period of financial stress, and negative yields for short-term U.S. Treasury securities, according to a Federal Reserve news release.
Under this hypothetical scenario, loan losses at the 33 participating bank holding companies would total $385 billion during the nine quarters tested, according to the release. That scenario projects those firms’ aggregate community equity tier 1 capital ratio, which compares high-quality capital to risk-weighted assets, would fall from the actual level of 12.3% in the fourth quarter of 2015 to a minimum level of 8.4%.
On the positive side, the Fed notes that these firms have added more than $700 billion in common equity capital since 2009. Capital acts as a buffer to absorb losses during an economic downturn and helps to ensure that losses are borne by shareholders, according to the release.
“The changes we make in each year’s stress scenarios allow supervisors, investors and the public to assess the resiliency of the banking firms in different adverse economic circumstances,” Fed board member Daniel K. Tarullo said in the release. “This feature is key to a sound stress testing regime, since the nature of possible future stress episodes is inherently uncertain.”
The Fed emphasized its stress scenario estimates were based only on hypothetical economic and financial market conditions and were not forecasts or expected outcomes.
This marks the sixth round of stress tests led by the Federal Reserve since 2009 and the fourth round required under the Dodd-Frank Act. The 33 firms tested represent more than 80% of domestic banking assets, according to the release.
The Federal Reserve Board also released the results of the hypothetical impact of a moderate recession and mild deflation in the U.S. Under that scenario, the aggregate common equity capital ratio of the 33 firms would fall from an actual 12.3% in the fourth quarter of 2015 to a minimum level of 10.5%, according to the release.
To learn more about the Fed’s stress test methodology and results, see http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160623a1.pdf