Magazine article American Banker

Fed Toughens Stress Test Scenarios for 2018

Magazine article American Banker

Fed Toughens Stress Test Scenarios for 2018

Article excerpt

Byline: John Heltman

WASHINGTON -- The Federal Reserve on Thursday released its 2018 stress testing scenarios, saying that it had dialed up its "severely adverse" scenario from last year.

The central bank said it toughened the test because it is designed to be countercyclical -- that is, contemplate more severe shocks when baseline conditions are better and less severe shocks when they are already unfavorable.

"This increase in severity reflects the Federal Reserve's scenario design framework for stress testing, which includes elements that create a more severe test of the resilience of large firms when current economic conditions are especially strong," the Fed document said.

The Fed conducts two separate stress testing scenarios every year on each of the bank holding companies under its supervision with more than $50 billion in assets.

The first test is the Dodd-Frank Act Stress Test, which examines a bank's balance sheet performance under the scenarios using a standard capital management plan. The second is the Comprehensive Capital Analysis and Review, which differs in that it uses the bank's own capital management plan to better assess how the bank might actually perform under the same conditions. Each test examines a bank's performance over nine future consecutive quarters.

Three scenarios are assessed: baseline, where the prevailing market conditions are similar to what is expected over the nine-quarter timeline; adverse, which indicates moderate economic malaise; and severely adverse, which contemplates a major recession along the lines of the 2008 financial crisis. …

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