Largest Financial Institutions Face Potential Losses of $685 Billion in Fed Stress Scenario Tests
Fed's Stress Test Results Reveal Bank Resilience, JPMorgan Challenges OCI Estimates
The Federal Reserve's annual stress test has once again demonstrated the resilience of the U.S.'s largest banks, with all participating banks maintaining enough capital to endure a scenario with a 10% unemployment rate, 36% house price decline, and 40% commercial real estate price plunge.
However, JPMorgan Chase has challenged the Federal Reserve's methodology, arguing that the Fed overestimated its "other comprehensive income" (OCI) in the stress test. According to JPMorgan, the Fed's assumptions and treatment of OCI lead to an artificially higher estimate of OCI losses, which depresses JPMorgan’s regulatory capital measures in the results of the stress test.
JPMorgan's argument is based on the contention that the Fed's stress test assumptions do not accurately reflect the bank's actual OCI, particularly how OCI components—such as unrealized gains or losses on securities—are accounted for during stressful scenarios. This affects JPMorgan Chase's reported capital ratios and the perceived loss absorption capacity under stress conditions.
In aggregate, the banks' capital levels fell by an average of 2.8 percentage points, the greatest proportional decline since 2018. Deutsche and UBS saw the steepest declines in common equity tier 1 capital from the severely adverse scenario, with Deutsche's buffer dropping by 13.3 percentage points, and UBS's falling by 9.3. The banks collectively would face losses of nearly $685 billion in this year's "severely adverse" scenario, higher than the $541 billion they stood to lose under 2023's test.
Rob Nichols, CEO of the American Bankers Association, stated that the continued strength and resilience of the banking sector is further evidence that recent regulations, including proposed higher capital standards, are unwarranted. Kevin Fromer, CEO of the Financial Services Forum, echoed this sentiment, stating that the additional capital requirements in the Basel III Endgame proposal are not justified.
The stress test posed an additional challenge for eight of the largest banks participating, under an "exploratory analysis" in which five large hedge funds implode, the eight banks would lose $70 billion to $85 billion. Tested banks would see $142 billion in losses from commercial and industrial loans, according to the test. Credit card delinquencies would account for $175 billion in theoretical losses to the larger field of 31 banks, according to the test.
Goldman Sachs saw the greatest CRE losses among tested banks, at 15.9%, while Ally would see the largest losses of any of the tested banks on credit cards, at 40.6%. BMO, at 5%, came closest to the minimum, followed by Citizens and HSBC, with 6.5% and 6.7%, respectively. Charles Schwab maintained a 25.2% capital ratio under the severe scenario, and TD, Deutsche Bank, JPMorgan Chase, BNY, State Street, Northern Trust, Morgan Stanley, Santander, and UBS also maintained capital buffers above 10%.
The Fed expects banks to wait until after markets close on Friday to publicize those plans. The Financial Services Forum and the American Bankers Association, among others, have responded to the stress test results.
[1] Federal Reserve's 2025 Supplementary Leverage Ratio (SLR) reform [2] Regulatory capital and risk alignment [3] JPMorgan's targeted resolution and stress testing documentation for 2025
- Despite the industry-wide decline in capital levels during the Federal Reserve's stress test, JPMorgan's business strategy is centered on refuting the Fed's methodology regarding the estimation of "other comprehensive income" (OCI), aiming to adjust the perceived loss absorption capacity within the banking-and-insurance sector.
- The Financial Services Forum and the American Bankers Association, in response to the stress test results, are focusing on advocating for regulatory capital reform, financial risk alignment, and pushing for the implementation of JPMorgan's targeted resolution and stress testing documentation for the year 2025, with an aim to promote a more balanced and accurate representation of banking finance.
