Fed includes ‘doomsday scenario’ in next round of stress tests

The Federal Reserve has specified the variables of the three scenarios that will be included in its 2013 comprehensive capital analysis and review (CCAR) stress tests, including a 'severely adverse' scenario of deep global recession and a stock market crash.

To comply with the Dodd-Frank Act, the Fed must specify at least three scenarios for both supervisory and company-run stress tests, to be applied to all large financial institutions in the US. The scenarios published on November 15 include baseline, adverse and severely adverse conditions designed to assess the capital adequacy of bank holding companies.

All scenarios start in the fourth quarter of 2012 and extend to the end of 2015. The rules specify a total of 26 variables, including measures of domestic economic activity, asset prices, interest rates and international economic conditions.

In the severely adverse scenario, US GDP contracts by nearly 5% by the end of 2013, equity prices fall more than 50% and unemployment increases by four percentage points from the current level. This would mean banks could withstand a failure by the US to resolve its ‘fiscal cliff' that most pundits believe could hit GDP by 4 percentage points, and appears to address concerns that last year's tests were not rigorous enough. The Fed stressed, however, that this was a worst-case scenario and not a forecast.

By contrast, the baseline scenario shows average growth of 2.75% per year, with a gradual decline in unemployment and low equity market volatility. The Fed said this was based on a survey of economic forecasters and does not represent its own outlook.

A total of 19 bank holding companies will be expected to comply with the rules, and the 11 firms with $50 billion or more in consolidated assets will also be subject to a capital plan review. Capital plans must be submitted by January 7, 2013.

The Fed noted the 19 banks had increased their aggregate core tier 1 capital from $420 billion in 2009 to $803 billion in the second quarter of 2012. During the 2012 stress tests, the majority of banks maintained capital levels above the minimum even under the severely adverse scenario, although four had one or more capital ratios drop below the minimum over the nine-quarter time horizon.

The 19 bank holding companies participating in 2013 are Ally Financial; American Express; Bank of America; The Bank of New York Mellon; BB&T; Capital One; Citigroup; Fifth Third Bancorp; Goldman Sachs; JP Morgan Chase; Keycorp; MetLife; Morgan Stanley; PNC Financial Services; Regions Financial Corporation; State Street; SunTrust Banks; US Bancorp; and Wells Fargo.