Michelle W Bowman: The future of stress testing and the stress capital buffer framework
Speech by Ms Michelle W Bowman, Member of the Board of Governors of the Federal Reserve System, at the Executive Council of the Banking Law Section of the Federal Bar Association, Washington DC, 10 September 2024.
The views expressed in this speech are those of the speaker and not the view of the BIS.
Thank you for the invitation to join you. Given the recent conclusion of the Board's stress test, it seems timely to share my thoughts on the stress testing program. In the past, I have noted reservations about the stress testing process, so today I'd like to discuss in greater detail the benefits, challenges, and issues I would like to see resolved as the stress testing program evolves in the future.
Earlier this summer, the Board announced the results of the supervisory stress tests. At a high level, all 31 banks subject to the test remained above their minimum common equity tier one (CET1) capital requirements from the hypothetical recession scenario. Under this scenario, banks would have absorbed projected hypothetical losses of nearly $685 billion, and would have experienced an aggregate CET1 capital decline of 2.8 percent. The hypothetical scenario included a 40 percent decline in commercial real estate prices, a substantial increase in office vacancies, a 36 percent decline in house prices, a spike in unemployment to a peak of 10 percent, and related declines in economic output. This year also saw the introduction of "exploratory" stress scenarios, which included two different funding stress scenarios, and for a subset of banks, included two trading book loss scenarios. The Board's press release announcing the results reported that large banks are well positioned to weather a severe recession and remain above minimum capital requirements.
More recently, the Fed announced the final individual capital requirements for all large banks, effective on October 1, 2024. The firm-specific capital requirements are "informed by" the stress test results, and include a 4.5 percent minimum capital requirement, a stress capital buffer that is set at a minimum of 2.5 percent, and if applicable, a capital surcharge for the most complex banks that is based on each firm's systemic risk. The announcement of this year's results also noted the modification of the stress capital buffer for a single firm based on a reconsideration request. While firms subject to the stress test have long had the ability to request reconsideration-and many have done so in the past-this was notable as it was the first time that a reconsideration request was successful in producing a change to a firm's stress capital buffer.