The nation’s 33 biggest banks have enough capital to withstand a severe economic contraction, the Federal Reserve said Thursday.
In its latest annual “stress tests” of the U.S. financial system, the Fed built a scenario under which the nation’s unemployment rate would more than double to 10%, and a severe contraction in commercial real estate and stock market values would cause losses of more than $600 billion.
Even in with those variables, the 33 largest banks would still, on average, have a capital ratio 9.7%, well above the 4.5% required by law, the Fed said. Capital ratios are an industry measure of how strong a cushion a bank holds against unexpected losses.
The “stress tests” have become an annual report card for the nation’s financial system since being implemented after the Great Recession and 2008 financial crisis. The biggest banks are required to pass these annual examinations before they can start paying out shareholders dividends and buying back shares. Banks will announce their plans for plans for dividends and buybacks on Monday.
The tests vary from year to year, but generally involve the Fed testing to see how steep the losses in the banking industry would be if unemployment were to skyrocket and economic activity were to severely contract. For example, the Federal Reserve has recently tested banks against the possibility of a double-dip recession caused by the coronavirus pandemic.
The Fed’s test is an academic exercise, and this examination is not predicting a recession, even though financial markets have increasingly priced in the possibility of a recession later this year as the nation’s central bank raises rates to combat inflation. This test was designed before Russia invaded Ukraine and before the current period of high inflation.
While 34 banks were tested in the Fed’s overall examination, one bank was not included in the individual results: Japanese bank MUFG, which is selling off its U.S. retail banking business and would not be subject to examinations once that deal is finalized. Overall 33 banks were individually scrutinized to see whether they would have enough capital, and all passed.