FED Releases Hypothetical Scenarios for Stress Test Exercise in 2020

FED released hypothetical scenarios for the stress test exercise in 2020. This year, the stress tests will evaluate 34 large banks with more than USD 100 billion in total assets and include two hypothetical scenarios: baseline and severely adverse. Banks are required to submit their capital plans and the results of their own stress tests to FED by April 06, 2020. FED will announce the results of the supervisory stress tests by June 30, 2020. In its announcement, FED has disclosed the list of banks that will be undergoing the exercise this year, along with the components that apply to each participating bank.

The severely adverse scenario and baseline scenarios are not forecasts. The severely adverse scenario describes a hypothetical sets of events designed to assess the strength of banking organizations. Similarly, the baseline scenario is in line with average projections from surveys of economic forecasters. Each scenario includes 28 variables—such as gross domestic product, the unemployment rate, stock market prices, and interest rates—covering domestic and international economic activity. The severely adverse scenario this year features a severe global recession in which the U.S. unemployment rate rises by 6.5 percentage points to 10% and elevated stress in corporate debt markets and commercial real estate. The scenarios start in the first quarter of 2020 and extend through the first quarter of 2023.

Banks with large trading operations will be required to factor in a global market shock component as part of their scenarios. This year’s shock features, among other things, heightened stress to trading book exposures to leveraged loans. Additionally, firms with substantial trading or processing operations will be required to incorporate a counterparty default scenario component. The counterparty default scenario component involves the instantaneous and unexpected default of the largest counterparty of a firm. 

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