Bank stress tests will pose a bigger economic drop from higher starting point in '22

Feb. 11, 2022 1:34 PM ETSCHW, AXP, BAC, JPM, GS, HSBC, C, COF, FITB, UBS, MS, WFC, USB, BK, BMO, TD, RY, MTB, KEY, STT, NTRS, PNC, HBAN, DB, CS, BCS, SAN, TFC, DFS, BNPQY, BNPQF, ALLY, CFG, MUFG, BMO:CA, TD:CA, RY:CABy: Liz Kiesche, SA News Editor14 Comments

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This year's stress tests conducted by the Federal Reserve Board will analyze large banks to determine if they have enough capital to continue operating if the economy should sour. All banks operating in the U.S. with over $100B in assets are required to participate. This year is the first year in which Charles Schwab (NYSE:SCHW) is required to take part.

The Fed will subject 34 large banks to its 2022 stress test, using a range of hypothetical scenarios. In the severely adverse scenario, the U.S. unemployment rate rises 5.75 percentage points to a peak of 10% over two years.

That scenario also envisions a global recession with heightened stress in commercial real estate prices and corporate debt markets. Specifically, banks will be tested for how they would weather a 40% drop in commercial real estate, widening corporate bond spreads, and collapsing asset, as well as increased market volatility.

The scenarios "appear modestly worse" but are based on a higher starting point than the 2021 tests, wrote Goldman Sachs analyst Richard Ramsden in a note to clients. In addition, "the Fed appears to be putting more stress on all components of the test, from markets, to corporates and consumers."

Jefferies analyst Ken Usdin considers the scenarios similar in severity vs. '21 scenarios, with different starting points. And Evercore ISI's Glenn Schorr explained it this way: "At first glance seemed slightly negative, but not a major surprise given a stronger macroeconomic backdrop vs. '21."

The international stress component appears to be less than last year's, said Goldman's Ramsden.

Overall, Schorr doesn't expect the stress test results to significantly change stock buyback expectations. Neither does he see capital constraints limiting lending activities. "However, we are keeping an eye on capital cushions and potential AOCI impacts from higher rates," Schorr wrote.

Jefferies' Usdin will be watching for rising global systemically important bank buffers and "bulky supplemental leverage ratio denominators," as "SLR has become more binding for some of the largest banks."

Banks with large trading operations will also be tested against a global market shock component that primarily stresses their trading positions. In addition, banks with substantial trading or custodial operations will be tested against the default of their largest counterparty.

Banks subject to both the global market shock and counterparty default tests, in addition to the regular stress test scenarios, are: Bank of America (NYSE:BAC), Barclays (NYSE:BCS) US, Citigroup (NYSE:C), Credit Suisse Holdings (USA) (NYSE:CS), Deutsche Bank's (NYSE:DB) U.S. unit, Goldman Sachs (NYSE:GS), HSBC (NYSE:HSBC) North America Holdings, JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), and Wells Fargo (NYSE:WFC).

Bank of New York Mellon (NYSE:BK) and State Street (NYSE:STT) will be subject to the counterparty default test in addition to the standard hypothetical scenarios.

Banks taking the standard stress test scenarios are Ally Financial (NYSE:ALLY), American Express (NYSE:AXP), BMO Financial (NYSE:BMO), BNP Paribas USA (OTCQX:BNPQF) (OTCQX:BNPQY), Capital One Financial (NYSE:COF), Charles Schwab (SCHW), Citizens Financial Group (NYSE:CFG), Discover Financial (NYSE:DFS), Fifth Third Bancorp (NASDAQ:FITB), Huntington Bancshares (NASDAQ:HBAN), KeyCorp (NYSE:KEY), M&T Bank (NYSE:MTB), MUFG Americas Holdings (NYSE:MUFG), Northern Trust (NASDAQ:NTRS), PNC Financial (NYSE:PNC), RBC US Group (NYSE:RY), Santander Holdings USA (NYSE:SAN), TD Group US (NYSE:TD), Truist Financial (NYSE:TFC), UBS Americas (NYSE:UBS), and U.S. Bancorp (NYSE:USB).

Last year, all 23 banks cleared minimum risk levels set by the Fed

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