Tags: federal reserve | banks | stress test | housing

Fed to Stress-Test Banks for Dire Stock, Housing Scenarios

Thursday, 23 October 2014 04:53 PM

The Federal Reserve said it will scrutinize how 31 large U.S. banks, including JPMorgan Chase & Co. and Citigroup Inc., would respond to a plunge in equity and housing prices and a sharp downturn in the global economy.

The annual tests, based on hypothetical scenarios, are the cornerstone of the Fed’s efforts to prevent a repeat of the 2008 financial crisis and to gauge the ability of banks to withstand economic turmoil. The Fed uses the exams to prod lenders into building up capital buffers. Firms that fail may have to forgo stock buybacks and higher dividends.

The “adverse and severely adverse scenarios” are designed to assess “the strength of banking organizations and their resilience to adverse economic environments,” the Fed said in documents released Thursday.

The “adverse” scenario outlined by the Fed differs from last year’s in a higher, flatter yield curve for Treasuries — much like the one released two years ago, according to the Fed. The scenario assumes a hypothetical weakening in global economic activity while domestic inflation kicks up a rapid increase in Treasury rates. The short-term rates would reach more than 2.5 percent in 2015 and almost 5.3 percent in 2017, while longer-term rates show a lesser increase under the scenario.

The rate rise would further risk banks’ funding costs, and commercial deposits would migrate into institutional money funds, under the adverse scenario.

Hypothetical Recession

The banks have to account for a mild, three-quarter U.S. recession starting in the last quarter of 2014, with real gross domestic product falling half a percent and unemployment over 7 percent and reaching 8 percent by the end of 2016, the Fed said in the report.

The recession would cause U.S. stock markets to slip 25 percent, drop housing prices by 13 percent and extend beyond the U.S. to a broad economic slowdown in Europe and the U.K., and weakness in Japan.

In the Fed’s “severely adverse” scenario, stocks decline fall by 60 percent by the fourth quarter of 2015 and housing prices fall by about 25 percent. Unemployment peaks at 10 percent, gross domestic product drops by 4.5 percent and the price of oil rises to $110 per barrel. Treasury yields drop to 1 percent.

This scenario also includes “severe recessions” the euro area, U.K. and Japan, and “below-trend growth in developing Asia,” the Fed said.

The six biggest banks must factor in a global market shock along with the scenarios, and the Fed said it will release specifics on that by Dec. 1. The Fed’s stress scenarios released today will be used beyond the agency’s testing of the biggest banks, also becoming the basis for banks’ internal stress tests mandated by the 2010 Dodd-Frank Act.

Banks will also have to test their strength under a third situation, called the “baseline” scenario, the Fed said today. It largely reflects the current outlook of private economists for a sustained, moderate expansion in the U.S. and a modestly declining jobless rate.

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The Federal Reserve said it will scrutinize how 31 large U.S. banks, including JPMorgan Chase and Citigroup, would respond to a plunge in equity and housing prices and a sharp downturn in the global economy.The annual tests, based on hypothetical scenarios, are...
federal reserve, banks, stress test, housing
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2014-53-23
Thursday, 23 October 2014 04:53 PM
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