The Federal Reserve released a number of economic scenarios on Thursday that the largest banks plan to use in the next set of stress tests to determine whether they could withstand a financial downturn.
Under the 2010 Dodd-Frank Act, stress testing is required for banks with more than $50 billion in assets and is designed to ensure that banks have enough capital back-up to cushion economic blows, Reuters reports.
In the most difficult of the three economic scenarios, banks would face a serious recession in the U.S. with a 12 percent unemployment rate, as well as economic recessions in both Europe and Japan. Another scenario involves a sharp decline in economic activity in China would also carry over to the rest of Asia.
“If the U.S. and China have a recession, so goes the world,” Walter Young, a director of the governance, regulatory and risk strategies division at Deloitte, said, according to Reuters. “It’s not unexpected. There’s really no curveball thrown to the banks from the Fed here.”
Additionally, regulators will examine six large bank-holding firms, including Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo, all of which have sizable trading divisions, to determine whether the companies could withstand a global economic shock.
The scenario involves a wide increase in interest rates, which would decrease the value of bank holdings’ investment bonds, like Treasury securities, Reuters reports.
Banks will also have an opportunity this year to adjust their plans to boost dividends or repurchase stock after the regulators finish their initial assessments of the banks’ capital plans.
Experts and analysts said that banks now have a better idea of what the Fed is looking for, and the opportunity to revise capital plans could prevent banks from failing the stress tests, as was the case for Citigroup last year when the Federal Reserve rejected its plan to return capital to shareholders.
“The Fed is going to have a much more open dialogue than they have had in the past when it was just pass-fail,” Paul Miller, an analyst at FBR Capital Markets, said, according to Reuters. “I am not expecting anybody to fail.”