FED Publishes Results of Stress Test and COVID Sensitivity Analysis
FED published results of the Dodd-Frank Act Stress Test (DFAST) for 2020, along with the results of an additional sensitivity analysis that explored the vulnerabilities of banks to the downside risks to the economy posed by the COVID-19 outbreak and the resulting response (alternatively COVID event). The DFAST exercise reveals that, in aggregate, the 33 firms subject to the supervisory stress test would experience substantial losses under the severely adverse scenario. Nevertheless, these firms could continue lending to businesses and households, due to the substantial buildup of capital since the financial crisis. Additionally, the results of the sensitivity analysis, using three alternative downside scenarios, show that banks are projected to remain above the minimum regulatory capital requirements.
Sensitivity analysis on impact of COVID-19 event
The sensitivity analysis assessed the resilience of large banks under three hypothetical recessions, or downside scenarios, which could result from the coronavirus event. The scenarios included a V-shaped recession and recovery, a slower, U-shaped recession and recovery, and a W-shaped, double-dip recession. In aggregate, loan losses for the 34 banks ranged from USD 560 billion to USD 700 billion in the sensitivity analysis and aggregate capital ratios declined from 12.0% in the fourth quarter of 2019 to between 9.5% and 7.7% under the hypothetical downside scenarios. Under the U- and W-shaped scenarios, most firms remain well-capitalized but several would approach minimum capital levels. The sensitivity analysis does not incorporate the potential effects of government stimulus payments and expanded unemployment insurance. Since the scenarios were developed in early April, certain economic and financial market indicators have improved somewhat. However, the path of the economy remains uncertain, so FED is taking several actions to help ensure that all firms remain sufficiently capitalized until the economy recovers. FED will
- Suspend share repurchases
- Cap dividend payments, allowing dividends according to a formula based on recent income
- Require banks to re-assess their capital needs and resubmit their capital plans later this year All large banks will be required to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty.
- Conduct additional stress analyses each quarter to determine if adjustments to this response are appropriate
The restrictions will apply for the third quarter of 2020 and may be extended by FED quarter-by-quarter, as the economic situation continues to evolve.
The results of the full stress test designed before the coronavirus are comparable to the V-shaped downside scenario in the sensitivity analysis, in aggregate, and show that all large banks remain strongly capitalized. The results suggest that, in the aggregate, the 33 firms subject to the supervisory stress test would experience substantial losses under the severely adverse scenario. Aggregate losses at the 33 firms under the severely adverse scenario are projected to be USD 552 billion. For the 18 firms for which stress test results were disclosed both last year and this year, total losses under the severely adverse scenario are USD 433 billion in DFAST 2020, compared to USD 410 billion for the same 18 firms in DFAST 2019. Aggregate loan losses as a percent of average loan balances in the severely adverse scenario are similar in DFAST 2020 compared to the past several years. The higher loss rates this year reflect, in part, the effect of the relatively more severe scenario
FED will use the results of this test to set the new stress capital buffer requirement for these firms, which will take effect, as planned, in the fourth quarter of the year. Additionally, FED will not be objecting to five foreign banks whose capital planning practices were evaluated as part of the stress tests. In DFAST 2020, FED published results for 33 firms subject to supervisory stress testing requirements, with 18 firms subject to annual supervisory stress test requirements and 15 firms subject to the two-year supervisory stress test cycle. The DFAST cycle begins in the first quarter of 2020 and ends in the first quarter of 2022. This year, FED also amended its stress testing requirements to remove the adverse scenario in its supervisory stress test.
Keywords: Americas, US, Banking, Stress Testing, Dodd-Frank Act, DFAST, Sensitivity Analysis, COVID-19, FED
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