On Thursday, the Federal Reserve announced that the nation’s major banks are in good shape and can withstand a severe economic contraction.
This year’s test was more demanding than last year’s, as banks have largely bounced back from the rocky days of the coronavirus pandemic that began in early 2020.
The most recent test factored in economic challenges like soaring unemployment and stress in commercial real estate and corporate debt markets. And with the threat of a recession now looming, the results are more salient than ever.
All banks held capital above the minimum capital requirement even as they are expected to report an aggregate loss of $612 billion, the results of a Fed stress test showed on Thursday.
Losses of the large banks rose over $50 billion compared to the 2021 test. That included more than $450 billion in loan losses and $100 billion in trading and counterparty losses.
Even in with those variables, the 33 largest banks would still, on average, have a capital ratio of 9.7%, well above the 4.5% required by law, the Fed said. Capital ratios are an industry measure of how strong a cushion a bank holds against unexpected losses.
Here’s what the Fed press release explained:
“The individual bank results from the stress test will factor directly into a bank’s capital requirements, mandating each bank to hold enough capital to survive a severe recession. If a bank does not stay above its capital requirements, it is subject to automatic restrictions on capital distributions and discretionary bonus payments.”
Earlier this week, Fed Chair Jerome Powell testified before members of the Senate that there is a “possibility” of recession.
Here’s what the policymaker explained:
“At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so. We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses. It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all.”
More details of this report from Daily Wire:
Last week, the Fed increased interest rates by 0.75% — the largest rate hike increment since 1994. The central bank already hiked rates by 0.5% in May — the largest such increase since 2000 — after a 0.25% rate hike from near-zero levels in March. Interest rates are now at 1.5% to 1.75%, with more increases likely on the way.
Rate hikes are intended to cut inflation by increasing the cost of borrowing money — a move that tends to slow economic activity. Many investors, however, have nevertheless urged the Fed to tighten its monetary policy.
“The only way to stop today’s raging inflation is with aggressive monetary tightening or with a collapse in the economy,” Pershing Square Capital Management CEO Bill Ackman said last month. “There is no prospect for a material reduction in inflation unless the Fed aggressively raises rates, or the stock market crashes, catalyzing an economic collapse and demand destruction.”
Meanwhile, key policymakers have started to acknowledge that they failed to accurately predict soaring inflation. Treasury Secretary Janet Yellen admitted that she and Jerome Powell “could have used a better term than transitory” to describe higher prices.
She told Congress earlier this month:
“There’s no question that we have huge inflation pressures, that inflation is really our top economic problem at this point and that it’s critical that we address it. I do expect inflation to remain high, although I very much hope that it will be coming down now.”
Back in 2008, bank insolvency threatened to plunge the economy into a deeper recession, forcing the federal government to purchase toxic assets from investment banks through the $700 billion Emergency Economic Stabilization Act.
The Fed began conducting its annual stress test in 2011 after the financial crisis.