U.S. Banks Are Getting Ready For Federal Reserve Worst Case

This week, the Federal Reserve will release the results of its annual “stress tests,” revealing whether or not the major U.S. lenders passed.

The recent financial crisis, in which Silicon Valley Bank and two other institutions collapsed, provides the impetus for this year’s examinations. 

Institutions must demonstrate they have sufficient capital to withstand more market volatility, similar to the sector’s upheaval this past spring.

Analysts have predicted a slight decrease in investment rewards.

The findings of the central bank’s health tests, which determine how much capital banks would need to survive a catastrophic economic slump, will be made public on Wednesday.

The outcomes inform a bank’s capital planning, determining how much money may be distributed to shareholders through dividends and share repurchases.

The Fed began the practice after the financial crisis of 2007-2009.

Banks will be subjected to even more scrutiny this year, but experts and company leaders believe the 23 banks being examined will pass with capital levels well above the required levels.

Bank of America, Citigroup Inc, Goldman Sachs Group,  JPMorgan Chase, Wells Fargo, and Morgan Stanley are some of the most well-known Wall Street banks that will be eyeballed.

Smaller banks, including US Bank, Capital One, and Citizens, will also be under the microscope.

Before this year’s financial crisis, in which Silicon Valley Bank and two other institutions collapsed, the 2023 criteria were developed. Significant unrealized losses on their U.S. Treasury bond holdings caused them to lose uninsured depositors when the Federal Reserve raised interest rates.

The Federal Reserve has taken some heat for failing to check how well banks would do in a rising interest rate environment before a catastrophic recession.

The real economic baseline in 2023 is predicted to be stronger than in past years, making the exam harder than in previous years. That makes the effects of unemployment increases and shrinking economies more palpable.

The “severely adverse” scenario in the 2022 stress test projected a 5.8 percentage point increase in unemployment. With employment on the rise, this rise is projected to reach 6.5 percentage points by 2023.

In light of this projected increase in modeled losses, industry watchers believe banks will be instructed to reserve somewhat more capital than they did in 2022.