America’s Big Banks Are Prepared for a Recession

America’s big banks are well prepared to weather a severe recession and continue to lend to households and businesses even during it, according to the results of the Federal Reserve’s annual bank stress test released Wednesday. The tests reaffirm the message that the banking storm of the last few months is under control. Even so, there are marked differences between entities and those that get the worst grade should be prepared to resist any market pressure.

According to the results, the two largest US banks have comfortably passed the test: JPMorgan (with a minimum capital of 11.1% at the worst moment of the period analyzed in the scenario) and Bank of America (10.6%), while the same as Goldman Sachs (10.1%) and Morgan Stanley (11.2%). Of the big ones, the one that gets the worst grade is Wells Fargo, whose principal capital ratio would fall to a minimum of 8.2%. The capital of Citigroup would mark a minimum of 9.1% and then go back to 9.7%.

The one that comes out of the test stronger is Charles Schwab, who was singled out during the banking storm, but gets the best grades, always with a capital above 20%, like Credit Suisse USA. At the other extreme, the banks that would see their capital levels erode to lower ratios would be Citizens (6.4%), Truist (6.7%), M&T (7%), PNC (7.9%) and Capital One (8%). Some of them have been singled out as the next weak links in the chain.

Barr’s allusion to humility makes all the sense after the fall of Silicon Valley Bank, Signature Bank and First Republic Bank, whose problems were not addressed in time by the supervisor. The authorities have managed to contain the banking storm, but that does not guarantee that there will be no new accidents. In this case, moreover, only 23 banks were examined because medium-sized banks, with assets between 100,000 and 250,000 million dollars, only have to pass the test every two years.

The drop also occurred as a result of not adequately managing interest rate risk and accelerated deposit flight. Interest rate risk was not examined in the stress tests, but for the first time an exploratory exercise has been carried out in this regard. Thus, the Federal Reserve has measured the resistance of the trading portfolios of the largest banks, putting them to the test against greater inflationary pressures and rises in interest rates.

This exercise has not been carried out to require more capital from banks but, according to the Federal Reserve, “to better understand the risks of their trading activities and to assess the possibility of subjecting banks to multiple tests in the future.” The results showed that the trading books of the largest banks were resistant to the tested rate hike, according to the supervisor

Stress tests are a tool to help ensure that large banks can sustain and lend to the economy during economic downturns. The test assesses the resilience of large banks by estimating their capital levels, losses, income and expenses in a hypothetical recession and financial market crisis, using data from the banks at the end of last year.

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The 23 banks analyzed remained above their minimum capital requirements during the hypothetical recession, despite expected total losses of $541 billion, according to the results for the year. In stressed situations, the risk-based capital ratio of aggregate common equity, which provides a cushion against losses, is expected to decline by 2.3 percentage points, to as low as 10.1%.

This year’s scenario included a severe global recession with a 40% decline in commercial property prices, a substantial increase in vacant offices and a 38% decline in house prices. The unemployment rate would rise by 6.4 percentage points to a maximum of 10% and economic output would decline proportionately, the tests show.

The entities included in this year’s test have approximately 20% of commercial real estate loans for offices and downtown areas in the hands of banks. The large expected drop in commercial real estate prices, combined with a substantial increase in office vacancy, is helping to bring projected loss rates in office real estate to roughly triple the levels reached during the 2008 financial crisis.

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