Publication alert: Fed - 2022 Stress Test Scenarios
We communicate that the Federal Reserve (Fed) has published the document 2022 Stress Test Scenarios.
1. Context
The Fed’s stress tests evaluate the resilience of large banks by estimating their losses, revenues, expenses and resulting capital levels under hypothetical recession scenarios into the future, with the aim to ensure that large banks are able to lend to households and businesses even in a severe recession. In 2021, the Fed published hypothetical scenarios describing two supervisory scenarios (baseline and severely adverse) that the Fed used to conduct the 2021 stress test.
In this context, the Fed has released the hypothetical scenarios for its 2022 bank stress tests in which 34 large banks will be tested against a severe global recession with heightened stress in commercial real estate and corporate debt markets.
2. Main points
General aspects. The scenarios start in the first quarter of 2022 and extend through the first quarter of 2025. Each scenario includes 28 variables; which are the same as the set provided in last year’s supervisory scenarios. The variables describing economic developments within the US include:
- Six measures of economic activity and prices (e.g percent changes in real and nominal GDP).
- Four aggregate measures of asset prices or financial conditions (e.g. indexes of house prices).
- Six measures of interest rates (e.g. the rate on 3-month Treasury bills).
Baseline scenario. The baseline scenario for the US is an economic expansion over the 13-quarter scenario period:
- The unemployment rate to about 3.25 percent by the end of the scenario.
- Real GDP growth declines from about 6 perccent at the end of 2021 to around 2 percent at the end of the scenario.
- CPI inflation also declines.
- The 3-month treasury rate increases from around 0 percent to about 1.5 percent at the end of the scenario.
Severely adverse scenario. The severely adverse scenario is characterized by a severe global recession accompanied by a period of heightened stress in commercial real estate and corporate debt markets. In this scenario:
- The unemployment rate climbs to a peak of 10 percent in the third quarter of 2023, a 5.75 percentage point increase relative to its fourth-quarter 2021 level.
- Real GDP declines more than 3.5 percent from the fourth quarter of 2021 to its trough in the first quarter of 2023.
- CPI inflation falls from an annual rate of 8.25 percent at the end of 2021 to an annual rate of about 1.25 percent in the third quarter of 2022.
- Short-term interest rates as measured by the 3-month treasury rate remain near zero throughout the scenario.
Global market shock component. The global market shock is a set of hypothetical shocks to a large set of risk factors reflecting general market distress and heightened uncertainty. Banking organizations with significant trading activity must consider the global market shock as part of their supervisory severely adverse scenario.
Counterparty default component. Large banks with substantial trading or custodial operations are required to incorporate a counterparty default scenario component into their supervisory severely adverse stress scenario for 2022 and recognize associated losses in the first quarter of the projection horizon.
3. Next steps
Following the publication of what-if scenarios for the 2022 bank stress test, the Fed is expected to publish the stress test methodology by the end of the first quarter of this year.