Fed releases hypothetical scenarios for stress tests

The Federal Reserve Board has announced the details of the hypothetical scenario of its annual stress test for 2023. The test, which is meant to gauge the resilience of large banks in a severe recession, will be conducted on 23 banks this year. The scenario for the stress test outlines a global recession, along with heightened stress in commercial and residential real estate markets, and corporate debt markets.

For the first time, the stress test will include an exploratory market shock component, which will assess the largest and most complex banks’ ability to withstand market distress and heightened uncertainty. The results of the exploratory market shock will not impact the capital requirements set by this year’s stress test, but they will provide a deeper understanding of the banks’ resilience to multiple scenarios.

As part of the hypothetical scenario, the U.S. unemployment rate would rise to a peak of 10%, with significant market volatility and a collapse in asset prices. In addition, banks with large trading operations will be tested against a global market shock component. The stress test will consider the banks’ losses, net revenue, and capital levels, which act as a cushion against losses, over a two-year period.

It is important to note that the scenarios presented in the stress test are not forecasts and should not be interpreted as predictions of future economic conditions. The table in the scenario document provides additional information on the components of the test that apply to each bank based on data as of Q3 2022.