The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC). This would be the first stress testing exercise that the banks in the US are expected to undergo after the bank crisis last year and, thus, is expected to attract higher scrutiny.
The regulators will test banks' abilities to withstand a broader array of hypothetical shocks this year after the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank last year. Thirty-two banks will be tested this year, in comparison to the 23 banks in 2023. The annual stress test evaluates the resilience of large banks by estimating losses, net revenue, and capital levels—which provide a cushion against losses—under hypothetical recession scenarios that extend two years into the future.
In 2024, banks will be tested against a severe global recession with heightened stress in commercial and residential real estate (CRE and RRE) markets as well as in corporate debt markets. The focus on CRE exposure assessment comes at a time when the New York Community Bancorp Inc. (NYCB)—a bank that is 164 years old and has 420 branches—has been in the news for facing a possible bankruptcy due to losses (USD 252 million, as reported on January 31, 2024) incurred on loans for the office and rent-regulated properties. The regional bank NYCB is said to have increased in size substantially via the acquisition of Flagstar Bank in 2022 and is supposed to have purchased certain assets, including the CRE loan book, of the failed Signature Bank last year. Due to the transaction related to Signature Bank around March 2023, the total assets of NYCB exceeded USD 100 billion, a regulatory threshold at which capital and liquidity requirements kick in. This incident also came on the heels of the CRE sector facing challenges in the form of financing difficulties amid high interest rates and lower office occupancy resulting from the increasing adoption of remote work. The severe scenario includes a 36% decline in house prices (versus 38% in the 2023 scenario) and a 40% decline in CRE prices, the same as last year's scenario. It also includes a nearly 6.5 percentage-point increase in the U.S. unemployment rate, peaking at 10%, which is also in line with last year.
The stress test for 2024 will also, for the first time, include an additional “exploratory analysis” of the banking system, which includes four separate hypothetical elements. Two of the hypothetical elements include funding stresses that cause a rapid repricing of a large proportion of deposits at large banks, while the other two elements include two sets of market shocks that will be applied only to the largest and most complex banks. These shocks hypothesize the failure of five large hedge funds, each under a different set of financial market conditions. Those conditions include expectations of reduced global economic activity with a negative outlook for long-term inflation and expectations of severe recessions in the United States and other countries. As per the FED announcement, the exploratory analysis will not affect bank capital requirements. Additionally, in 2024, large banks with significant trading volumes will face an additional counterparty default scenario component to assess the impact of a default by the single largest counterparty. FED, the central bank in the US, is expected to publish aggregate results alongside the annual stress test results in June 2024.
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