Fed releases 2025 stress test scenarios
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The Federal Reserve unveiled its annual stress test scenarios for large banks Wednesday, putting them through severe global recession scenarios with added stress in commercial, residential real estate and corporate debt markets.
This year, 22 banks will be tested for resilience in harsh economic conditions, compared to 32 last year . The central bank has included two additional hypothetical elements to prove the various risks through its “exploratory analysis” of the banking system, though the analysis will not impact capital requirements, the Fed noted.
This year, the test will include a U.S. unemployment rate jump of nearly 5.9 percentage points, to 10%. The test also features severe market volatility, widening corporate bond spreads, and a collapse in asset prices, including about a 33% decline in house prices and a 30% decline in commercial real estate prices.
The international section of the stress test considers recession in four countries or country blocs, with Japan and developing Asia experiencing deflation.
Banks with major trading operations face additional stress tests that involve global market shock testing for trading positions and the largest counterparty default testing for banks with substantial trading and custodial operations.
This year, the Fed's exploratory analysis has two new elements: first, testing bank resilience to non-bank financial sector shocks during severe recession; second, a market shock applied to only the largest and most complex banks, hypothesizing the failure of five large hedge funds.
The exploratory analysis differs from the stress test since it focuses on system-wide hypothetical risks rather than firm-specific impacts, the Fed said. The results of the main stress test and the exploratory scenarios will be published in June.
In December, the American Bankers Association, the Bank Policy Institute, the Ohio Chamber of Commerce, the Ohio Bankers League, and the Chamber of Commerce of the United States of America sued the Fed’s board of governors in U.S. District Court for the Southern District of Ohio, alleging the central bank’s stress testing framework violates the Administrative Procedure Act.
The ABA advocated not to eliminate stress testing but to subject scenarios and models to public transparency through a proper rulemaking process. The complaint claimed that the lack of transparency and volatility in the results makes it difficult for banks to plan and manage capital effectively, leading to higher borrowing costs for their customers.
“While we support stress testing as an important risk management tool, ABA has long advocated for the Federal Reserve to increase the transparency of its stress testing program, which shields key components like supervisory models from public view,” Rob Nichols , president and CEO of ABA, said in a statement in December.
“The opaque nature of these tests undermines their value for providing meaningful insights into bank resilience….the Fed should publish the supervisory models and stress scenarios and invite public comment, which would enable banks and the public to better understand and prepare for regulatory expectations, reducing uncertainty and promoting a fairer, more predictable regulatory environment,” Nichols added.
Just prior to the lawsuit’s filing, the central bank had said it plans to reduce stress test volatility and improve model transparency this year. Additionally, it will open a public comment process on its changes to the stress test.
The Fed's stress test scenarios begin from the first quarter of 2025 and extend to the first quarter of 2028. Each scenario includes 28 variables, unchanged from last year’s.
The banks tested include American Express, Bank of America, BNY, Barclays US, BMO, Capital One, Charles Schwab, Citi., DB USA Corporation, Goldman Sachs, JPMorgan Chase , M&T Bank, Morgan Stanley, Northern Trust, PNC , RBC US Group Holdings, State Street, TD Group US Holdings, Truist, UBS Americas Holding, U.S. Bank and Wells Fargo.
Analysts at Keefe, Bruyette & Woods said assumptions appear less harsh this year than last year.
“Overall, we believe the 2025 assumptions are less stressful than recent tests with lower market declines, lower [market volatility index], and lower changes in unemployment, residential, and commercial mortgage indexes,” the analysts said in their research note, adding “modest headwinds” for JPMorgan and Bank of America with potentially less benefits from lower accumulated other comprehensive income.
Generally, capital markets should perform better than last year and are more favorable for Morgan Stanley and Goldman Sachs specifically, the analysts noted.