The largest US banks have demonstrated sufficient resilience to withstand a severe recession while maintaining lending to households and businesses, according to the Federal Reserve's annual bank resilience test conducted on Wednesday.
The importance of the stress tests was heightened this year following the collapse of three US banks, which sent shockwaves through the banking system.
All 23 banks subject to the Fed's examination fared better this year compared to the previous year, despite being subjected to a more painful worst-case scenario.
While the banks tested remained above their minimum capital requirements even in the worst-case scenario, they were projected to collectively lose $541 billion. Capital ratios would decline by 2.3 percentage points to 10.1%, more than double the requirement.
Last year, the tests revealed that the banks would suffer a loss of $612 billion, with capital ratios declining by 2.7 percentage points to 9.7%.
In a statement, Michael Barr, the Fed's vice chair for supervision, commented: "Today's results confirm that the banking system remains strong and resilient. We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses."
The stress tests, designed to evaluate banks' performance in a high-stress climate, were developed prior to the unfolding crisis and did not account for factors such as rising interest rate risk, which played a significant role in the recent bank failures.
Under this year's hypothetical recession condition, the unemployment rate rose by 6.5 percentage points over two years, and home prices declined by 38%. Commercial real estate prices were assumed to plunge by 40%.
Although all banks passed the stress tests, performance varied significantly among them, with mid-sized banks like Capital One and Citizens Bank experiencing steeper losses and larger hits to their capital ratios compared to the average.
Capital One suffered the largest loan loss rate at 14.7%, while Charles Schwab had the smallest rate at 1.3% and the highest capital buffer.
The results from the stress tests will be used to determine updated stock buyback and dividend plans for the banks, which will be announced after markets close on Friday.
Contact the author at jon.hopkins@proactiveinvestors.com