The Federal Reserve Board has disclosed the hypothetical scenarios for its annual stress test. These scenarios are designed to enable the board to investigate various elevated and extended recession risks through an exploratory analysis.
According to a press release from the Federal Reserve Board, these stress tests are conducted annually to evaluate the resilience of large banks. During these exercises, the board calculates losses, net revenue, and capital levels.
As stated in the press release, this year's stress test will involve 32 banks participating in the "Severely Adverse Scenario," based on data as of the third quarter of 2023. This scenario entails a severe global recession that lasts for two years. It features unemployment surging into double digits, corporate bond spreads widening, asset prices plummeting, and commercial and residential real estate prices collapsing. Banks with substantial trading operations will also be tested against a global market shock.
The press release further states that the 2024 exploratory analysis comprises four distinct hypothetical elements aimed at assessing the banking system's resilience to a range of risks. These include rapid repricing of a large proportion of deposits at major banks. However, these elements will vary in terms of interest rates and economic conditions, ranging from a moderate recession with rising inflation and interest rates to a severe global recession with escalating and persistent inflation and increasing interest rates. The largest and most complex banks will face two additional elements for the exploratory analysis—two sets of market shocks that hypothesize five large hedge funds failing under different financial market conditions.
Further details can be found in the "2024 Stress Test Scenarios" document published on the board's website, according to the press release.