Federal Reserve Regulatory Service
4-792
APPENDIX A—Policy Statement on the Scenario Design Framework for Stress Testing
1. Background
(a) The Board has imposed stress testing requirements through its regulations (stress test rules) implementing section 165(i) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act), section 10(g) of the Home Owners' Loan Act, and section 401(e) of the Economic Growth, Regulatory Relief, and Consumer Protection Act, and through its capital plan rule (§ 225.8). Under the stress test rules, the Board conducts a supervisory stress test of each bank holding company with total consolidated assets of $100 billion or more, intermediate holding company of a foreign banking organization with total consolidated assets of $100 billion or more, and nonbank financial company that the Financial Stability Oversight Council has designated for supervision by the Board (together, covered companies).1 In addition, under the stress test rules, certain firms are also subject to company-run stress test requirements.2 The Board will provide two different sets of conditions (each set, a scenario), including baseline and severely adverse scenario for both supervisory and company-run stress tests (macroeconomic scenarios).3
(b) The stress test rules provide that the Board will notify covered companies, by no later than February 28 of each year, of the scenarios it will use to conduct its supervisory stress tests and provide, also by no later than February 28, covered companies and other financial companies subject to the final rules, the set of scenarios they must use to conduct their company-run stress tests. Under the stress test rules, the Board may require certain companies to use additional components in the severely adverse scenario or additional scenarios. For example, the Board expects to require large banking organizations with significant trading activities to include a trading and counterparty component (market shock, described in the following sections) in their severely adverse scenario. The Board will provide any additional components or scenarios by no later than March 1 of each year.4 The Board expects that the scenarios it will require the companies to use will be the same as those the Board will use to conduct its supervisory stress tests (together, stress test scenarios).
(c) In addition, section 225.8 (capital plan rule) requires covered companies to submit annual capital plans, including stress test results, to the Board in order to allow the Board to assess whether they have robust, forward-looking capital planning processes and have sufficient capital to continue operations throughout times of economic and financial stress.5
(d) Stress tests required under the stress test rules and under the capital plan rule require the Board and financial companies to calculate pro-forma capital levels—rather than ''current'' or actual levels—over a specified planning horizon under baseline and stressful scenarios. This approach integrates key lessons of the 2007–2009 financial crisis and subsequent stress events into the Board's supervisory framework. During the financial crisis, investor and counterparty confidence in the capitalization of financial companies eroded rapidly in the face of changes in the current and expected economic and financial conditions, and this loss in market confidence imperiled companies' ability to access funding, continue operations, serve as a credit intermediary, and meet obligations to creditors and counterparties. Importantly, such a loss in confidence occurred even when a financial institution's capital ratios were in excess of regulatory minimums. This is because the institution's capital ratios were perceived as lagging indicators of its financial condition, particularly when conditions were changing.
(e) The stress tests required under the stress test rules and capital plan rule are a valuable supervisory tool that provide a forward-looking assessment of large financial companies' capital adequacy under hypothetical economic and financial market conditions. Currently, these stress tests primarily focus on credit risk, operational risk, and market risk—that is, risk of mark-to-market losses associated with companies' trading and counterparty positions—and not on other types of risk, such as liquidity risk. Pressures stemming from these sources are considered in separate supervisory exercises. No single supervisory tool, including the stress tests, can provide an assessment of a company's ability to withstand every potential source of risk.
(f) Selecting appropriate scenarios is an especially significant consideration for stress tests required under the capital plan rule, which ties the review of a company's performance under stress scenarios to its ability to make capital distributions. More severe scenarios, all other things being equal, generally translate into larger projected declines in banks' capital. Thus, a company would need more capital today to meet its minimum capital requirements in more stressful scenarios and have the ability to continue making capital distributions, such as common dividend payments. This translation is far from mechanical, however; it will depend on factors that are specific to a given company, such as underwriting standards and the company's business model, which would also greatly affect projected revenue, losses, and capital.
2. Overview and Scope
(a) This policy statement provides more detail on the characteristics of the stress test scenarios and explains the considerations and procedures that underlie the approach for formulating these scenarios. The considerations and procedures described in this policy statement apply to the Board's stress testing framework, including to the stress tests required under subparts B, E, and F of this part as well as the Board's capital plan rule (section 225.8).6
(b) Although the Board does not envision that the broad approach used to develop scenarios will change from year to year, the stress test scenarios will reflect changes in the outlook for economic and financial conditions and changes to specific risks or vulnerabilities that the Board, in consultation with the other federal banking agencies, determines should be considered in the annual stress tests. The stress test scenarios should not be regarded as forecasts; rather, they are hypothetical paths of economic variables that will be used to assess the strength and resilience of the companies' capital in various economic and financial environments.
(c) The remainder of this policy statement is organized as follows. Section 3 provides a broad description of the baseline and severely adverse scenarios and describes the relationship between the macroeconomic scenario and the market shock component of the severely adverse scenario applicable to companies with significant trading activity. This section also describes the types of variables that the Board expects to include in the macroeconomic scenarios and the market shock component. Section 4 describes the Board's approach for developing the macroeconomic scenarios, and section 5 describes the approach for the market shocks. Section 6 provides a timeline for the formulation and publication of the macroeconomic assumptions and market shocks.
3. Content of the Stress Test Scenarios
(a) The Board will publish two different scenarios, including baseline and severely adverse conditions, for use in stress tests required in the stress test rules.7 In general, the Board anticipates that it will not issue additional scenarios. Specific circumstances or vulnerabilities that in any given year the Board may determine require particular vigilance to help ensure the resilience of the banking sector may be captured in the severely adverse scenario. The Board would expect to explain such a determination through the comment process in those stress test cycles.
(b) While the Board generally expects to use the same scenarios for all companies subject to the final rule, it may require a subset of companies—depending on a company's financial condition, size, complexity, risk profile, scope of operations, or activities, or risks to the U.S. economy—to include additional scenario components or additional scenarios that are designed to capture different effects of adverse events on revenue, losses, and capital. One example of such components is the market shock that applies only to companies with significant trading activity. Additional components or scenarios may also include other stress factors that may not necessarily be directly correlated to macroeconomic or financial assumptions but nevertheless can materially affect companies' risks, such as the unexpected default of a major counterparty.
(c) Early in each stress testing cycle, the Board plans to publish the macroeconomic scenarios along with a brief narrative summary that provides a description of the economic situation underlying the scenario and explains how the scenarios have changed relative to the previous year. In addition, to assist companies in projecting the paths of additional variables in a manner consistent with the scenario, the narrative will provide descriptions of the general path of some additional variables. These descriptions will be general—that is, they will describe developments for broad classes of variables rather than for specific variables—and will specify the intensity and direction of variable changes but not numeric magnitudes. These descriptions should provide guidance that will be useful to companies in specifying the paths of the additional variables for their company-run stress tests. Note that in practice it will not be possible for the narrative to include descriptions of all the additional variables that companies may need for their company-run stress tests. In cases where scenarios are designed to reflect particular risks and vulnerabilities, the narrative will also explain the underlying motivation for these features of the scenario. The Board also plans to release a description of the market shock components.
3.1 Macroeconomic Scenarios
(a) The macroeconomic scenarios will consist of the future paths of a set of economic and financial variables.8 The economic and financial variables included in the scenarios will likely comprise those included in the ''2014 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule'' (2013 supervisory scenarios). The domestic U.S. variables provided for in the 2013 supervisory scenarios included:
(1) Six measures of economic activity and prices: Real and nominal gross domestic product (GDP) growth, the unemployment rate of the civilian non-institutional population aged 16 and over, real and nominal disposable personal income growth, and the Consumer Price Index (CPI) inflation rate;
(2) Four measures of developments in equity and property markets: The Core Logic National House Price Index, the National Council for Real Estate Investment Fiduciaries Commercial Real Estate Price Index, the Dow Jones Total Stock Market Index, and the Chicago Board Options Exchange Market Volatility Index; and
(3) Six measures of interest rates: The rate on the 3-month Treasury bill, the yield on the 5-year Treasury bond, the yield on the 10-year Treasury bond, the yield on a 10-year BBB corporate security, the prime rate, and the interest rate associated with a conforming, conventional, fixed-rate, 30-year mortgage
(b) The international variables provided for in the 2014 supervisory scenarios included, for the euro area, the United Kingdom, developing Asia, and Japan:
(1) Percent change in real GDP;
(2) Percent change in the CPI or local equivalent;
(3) The U.S./foreign currency exchange rate.9
(c) The economic variables included in the scenarios influence key items affecting financial companies’ net income, including pre-provision net revenue and credit losses on loans and securities. Moreover, these variables exhibit fairly typical trends in adverse economic climates that can have unfavorable implications for companies’ net income and, thus, capital positions.
(d) The economic variables included in the scenario may change over time. For example, the Board may add variables to a scenario if the international footprint of companies that are subject to the stress testing rules changed notably over time such that the variables already included in the scenario no longer sufficiently capture the material risks of these companies. Alternatively, historical relationships between macroeconomic variables could change over time such that one variable (e.g., disposable personal income growth) that previously provided a good proxy for another (e.g., light vehicle sales) in modeling companies' pre-provision net revenue or credit losses ceases to do so, resulting in the need to create a separate path, or alternative proxy, for the other variable. However, recognizing the amount of work required for companies to incorporate the scenario variables into their stress testing models, the Board expects to eliminate variables from the scenarios only in rare instances.
(e) The Board expects that the company may not use all of the variables provided in the scenario, if those variables are not appropriate to the company's line of business, or may add additional variables, as appropriate. The Board expects the companies to ensure that the paths of such additional variables are consistent with the scenarios the Board provided. For example, the companies may use, as part of their internal stress test models, local-level variables, such as state-level unemployment rates or city-level house prices. While the Board does not plan to include local-level macro variables in the stress test scenarios it provides, it expects the companies to evaluate the paths of local-level macro variables as needed for their internal models, and ensure internal consistency between these variables and their aggregate, macroeconomic counterparts. The Board will provide the macroeconomic scenario component of the stress test scenarios for a period that spans a minimum of 13 quarters. The scenario horizon reflects the supervisory stress test approach that the Board plans to use. Under the stress test rules, the Board will assess the effect of different scenarios on the consolidated capital of each company over a forward-looking planning horizon of at least nine quarters.
3.2 Market Shock Component
(a) The market shock component of the severely adverse scenario will only apply to companies with significant trading activity and their subsidiaries.10 The component consists of large moves in market prices and rates that would be expected to generate losses. Market shocks differ from macroeconomic scenarios in several ways, both in their design and application. For instance, market shocks that might typically be observed over an extended period (e.g., 3 months) are assumed to affect the market value of the companies' trading assets and liabilities immediately. In addition, under the stress test rules, the as-of date for market shocks will usually differ from the as-of date of the macroeconomic scenario, and the Board will provide the as-of date for market shocks within two weeks of the date occurring. Finally, as described in section 4, the market shock includes a much larger set of risk factors than the set of economic and financial variables included in macroeconomic scenarios. Broadly, these risk factors include shocks to financial market variables that affect asset prices, such as a credit spread or the yield on a bond, and, in some cases, the value of the position itself (e.g., the market value of securitized positions).
(b) The Board envisions that the market shocks will include shocks to a broad range of risk factors that are similar in granularity to those risk factors that trading companies use internally to produce profit and loss estimates, under stressful market scenarios, for all asset classes that are considered trading assets, including public equities, credit, interest rates, foreign exchange rates, and commodities. Examples of risk factors include, but are not limited to:
(1) Public equity indices to which companies with significant trading activity may have exposure, along with term structures of implied volatilities;
(2) Cross-currency foreign exchange rates of selected currencies, along term structures of implied volatilities;
(3) Term structures of government rates (e.g., U.S. Treasuries), interbank rates (e.g., swap rates) and potentially other key rates (e.g., commercial paper) for developed markets and for developing and emerging market nations to which companies may have exposure;
(4) Term structures of implied volatilities that are key inputs to the pricing of interest rate derivatives;
(5) Term structures of futures prices for energy products including crude oil (differentiated by country of origin), natural gas, and power;
(6) Term structures of futures prices for metals and agricultural commodities; and
(7) Credit spreads or instrument prices for credit-sensitive product segments including: corporate bonds, credit default swaps, and collateralized debt obligations by risk; non-agency residential mortgage-backed securities and commercial mortgage-backed securities by risk and vintage; sovereign debt; and, municipal bonds.
(c) The Board expects to structure the market shock component so that it reflects two separate market shock scenarios, which would occur on the same date within the stress test. To calculate trading and counterparty losses for a given stress test, the Board expects that the losses from whichever market shock scenario produces the largest dollar losses would be used to determine a firm's stress test results. This approach can help improve the risk capture of the stress test.
4. Approach for Formulating the Macroeconomic Assumptions for Scenarios
(a) This section describes the Board's approach for formulating macroeconomic assumptions for each scenario. The methodologies for formulating this part of each scenario differ by scenario, so these methodologies for the baseline and severely adverse scenarios are described separately in each of the following subsections.
(b) In general, the baseline scenario will reflect the most recently available consensus views of the macroeconomic outlook expressed by professional forecasters, government agencies, and other public-sector organizations as of the beginning of the stress-test cycle. The severely adverse scenario will consist of a set of economic and financial conditions that reflect the conditions of post-war U.S. recessions.
(c) Each of these scenarios is described further in sections below as follows: Baseline (subsection 4.1) and severely adverse (subsection 4.2).
4.1 Approach for Formulating Macroeconomic Assumptions in the Baseline Scenario
(a) The stress test rules define the baseline scenario as a set of conditions that affect the U.S. economy or the financial condition of a banking organization, and that reflect the consensus views of the economic and financial outlook. Projections under a baseline scenario are used to evaluate how companies would perform in more likely economic and financial conditions. The baseline serves also as a point of comparison to the severely adverse scenario, giving some sense of how much of the company's capital decline could be ascribed to the scenario as opposed to the company's capital adequacy under expected conditions.
(b) The baseline scenario will be developed around a macroeconomic projection that captures the prevailing views of private-sector forecasters (e.g., Blue Chip Consensus Forecasts and the Survey of Professional Forecasters), government agencies, and other public-sector organizations (e.g., the International Monetary Fund and the Organization for Economic Co-operation and Development) near the beginning of the annual stress-test cycle. The baseline scenario is designed to represent a consensus expectation of certain economic variables over the time period of the tests and it is not the Board's internal forecast for those economic variables. For example, the baseline path of short-term interest rates is constructed from consensus forecasts and may differ from that implied by the Federal Open Market Committee's Summary of Economic Projections.
(c) For some scenario variables—such as U.S. real GDP growth, the unemployment rate, and the consumer price index—there will be many different forecasts available to project the paths of these variables in the baseline scenario. For others, a more limited number of forecasts will be available. If available forecasts diverge notably, the baseline scenario will reflect an assessment of the forecast that is deemed to be most plausible. The Board also considers the output of a macroeconomic model, for which the Board will maintain a description separately on the Board's website, developed by Board staff for use in constructing the values of some of the variables in the scenarios for the annual stress test. In setting the paths of variables in the baseline scenario, particular care will be taken to ensure that, together, the paths present a coherent and plausible outlook for the U.S. and global economy, given the economic climate in which they are formulated. However, the macroeconomic model was designed to meet the specific needs of the stress testing program, and the resulting baseline scenarios are not Federal Reserve forecasts.
4.2 Approach for Formulating the Macroeconomic Assumptions in the Severely Adverse Scenario
The stress test rules define a severely adverse scenario as a set of conditions that affect the U.S. economy or the financial condition of a covered company and that overall are significantly more severe than those associated with the baseline scenario. The covered company will be required to publicly disclose a summary of the results of its stress test under the severely adverse scenario, and the Board intends to publicly disclose the results of its analysis of the covered company under the severely adverse scenario.
4.2.1 General Approach: The Recession Approach
(a) The Board intends to use a recession approach to develop the severely adverse scenario. In the recession approach, the Board will specify the future paths of variables to reflect conditions that characterize post-war U.S. recessions, generating either a typical or specific recreation of a post-war U.S. recession. The Board chose this approach because it has observed that the conditions that typically occur in recessions—such as increasing unemployment, declining asset prices, and contracting loan demand—can put significant stress on companies' balance sheets. This stress can occur through a variety of channels, including higher loss provisions due to increased delinquencies and defaults; losses on trading positions through sharp moves in market prices; and lower bank income through reduced loan originations. For these reasons, the Board believes that the paths of economic and financial variables in the severely adverse scenario should, at a minimum, resemble the paths of those variables observed during a recession.
(b) This approach requires consideration of the type of recession to feature. All post-war U.S. recessions have not been identical: Some recessions have been associated with very elevated interest rates, some have been associated with sizable asset price declines, and some have been relatively more global. Recessions that are caused by or exacerbated by a financial crisis often are deeper and more protracted than other recessions. The Board therefore believes that the severely adverse scenario should be triggered by a sudden and substantial increase in risk aversion and uncertainty that causes sharp declines in risky financial asset prices, lower interest rates on safe assets, and a rise in volatility big enough to disrupt functioning in some markets. Although markets resume normal functioning within a few months, the rise in uncertainty and decline in wealth causes businesses to take nearly simultaneous steps to reduce employment and investment and households to reduce spending. Negative feedback effects between contracting economic activity and financial markets' response lead to a deep and prolonged decline in overall economic activity, inflation, and asset prices followed by a shallow recovery.
(c) Indeed, the most common features of recessions are increases in the unemployment rate and contractions in aggregate incomes and economic activity. For this and the following reasons, the Board intends to use a rise in the unemployment rate as the primary basis for calibrating the severity of the severely adverse scenario. First, the unemployment rate is likely the most representative single summary indicator of adverse economic conditions. Second, in comparison to GDP, labor market data have traditionally featured more prominently than GDP in the set of indicators that the National Bureau of Economic Research reviews to inform its recession dates.11 Third and finally, the growth rate of potential output can cause the size of the decline in GDP to vary between recessions. While changes in the unemployment rate can also vary over time due to demographic factors, this seems to have more limited implications over time relative to changes in potential output growth. The unemployment rate used in the severely adverse scenario will reflect an unemployment rate that has been observed in severe post-war U.S. recessions, measuring severity by the absolute level of and relative increase in the unemployment rate.12
(d) The Board believes that the severely adverse scenario should also reflect a housing recession. The house prices path set in the severely adverse scenario will reflect developments that have been observed in post-war U.S. housing recessions, measuring severity by the absolute level of and relative decrease in the house prices.
(e) As described below, the Board has developed guides for several additional variables including equity prices; the Chicago Board Options Exchange's Volatility Index (VIX); BBB corporate spread (relative to the 10-year Treasury yield); conventional, conforming, 30-year fixed-rate mortgage spread (relative to the 10-year Treasury yield), commercial real estate prices, and 5-year and 10-year Treasury yields. The international variables (GDP, inflation, and exchange rates) are also subject to guides.
(f) The Board's specification of the paths of the macroeconomic and financial market variables listed in paragraph 4.2.1(e) will be informed by their behavior during previous recessions or other periods of financial stress, as well as informed assessments of how that behavior co-moved with the paths of unemployment, income, house prices, and activity during periods of macrofinancial stress. Some of these other variables, however, have taken divergent paths in previous recessions (e.g., foreign GDP). The analysis that the Board conducted to develop the guides informed its judgment in selecting the appropriate ranges for the peak or trough, and the timing of that peak or trough. In general, the path for these variables also will be based on their underlying structure at the time that the scenario is designed (e.g., economic or financial-system vulnerabilities in other countries).
(g) The Board considered alternative methods for scenario design of the severely adverse scenario, including a probabilistic approach. The probabilistic approach constructs a baseline forecast from a large-scale macroeconomic model and identifies a scenario that would have a specific probabilistic likelihood given the baseline forecast. The Board believes that, at this time, the recession approach is better suited for developing the severely adverse scenario than a probabilistic approach because it guarantees a recession of some specified severity. In contrast, the probabilistic approach requires the choice of an extreme tail outcome—relative to baseline—to characterize the severely adverse scenario (e.g., a 5 percent or a 1 percent tail outcome). In practice, this choice is difficult as adverse economic outcomes are typically thought of in terms of how variables evolve in an absolute sense rather than how far they lie in the probability space away from the baseline. In this sense, a scenario featuring a recession may be somewhat clearer and more straightforward to communicate. Finally, the probabilistic approach relies on estimates of uncertainty around the baseline scenario and such estimates are in practice model-dependent.
4.2.2 Setting Variables in the Severely Adverse Scenario
(a) Generally, the variables in the severely adverse scenario will be specified to be consistent with their expected behavior in severe recessions or periods of market stress. The approach for specifying the paths of these variables in the scenario will reflect the Board's assessment of:
(1) how economic models suggest that these variables should evolve given the path of the unemployment rate,
(2) how these variables have typically evolved in past U.S. recessions or other relevant periods of significant stress in particular asset markets, and
(3) other relevant factors, including the current state of the economy; the level of vulnerabilities in the financial system; and consensus estimates of long-run equilibrium values of potential GDP, interest rates, and inflation expectations.
(b) For certain variables subject to guides that provide a range or potential values (BBB spread, VIX, commercial real estate prices, and mortgage rate spread), the Board expects that it could be appropriate to set the paths for these variables at similar levels of severity. In making this determination, the Board would consider the expected severity of the unemployment rate and house prices variables and the prevailing macroeconomic and financial conditions described in the baseline scenario.
(c) The expected trajectories for the variables related to unemployment, long-term bond yields and spreads, asset prices, and volatility will be informed by quantitative guides. These guides provide plausible ranges within which the Board expects to choose the level of the peak or trough that each of these variables will reach in the scenario, and the timing of that peak or trough. The Board's choices relative to those ranges will be informed by the factors listed in paragraph 4.2.2(a).
(d) Economic models—such as medium-scale macroeconomic models—should be able to generate plausible paths consistent with the unemployment rate for a number of scenario variables, such as real GDP growth, CPI inflation, and short-term interest rates, which have relatively stable (direct or indirect) relationships with the unemployment rate (e.g., Okun's Law, the Phillips Curve, and interest rate feedback rules). The Board has developed a model specifically structured and calibrated to the needs of the stress testing program to inform the trajectories of these variables (as well as disposable personal income, or DPI), a description of which will be maintained on the Board's website. The output of this model is not a forecast of the Federal Reserve.
(e) In addition, judgment is necessary in projecting the path of a scenario's international variables. Recessions that occur simultaneously across countries are an important source of stress to the balance sheets of companies with notable international exposures but are not a typical feature of the international economy even when the U.S. is in recession. As a result, simply adopting the typical path of international variables in a severe U.S. recession would likely underestimate the risks stemming from the international economy. Consequently, an approach that uses the guides set out in section 4.2.2.10, and both judgment and economic models informs the path of international variables.
(f) The Board expects that the variables described in this section 4.2.2 will be specified in the annual scenarios in the severely adverse scenario to be consistent with certain scenario design principles and the guides for each variable below. In designing these guides and setting the values for the variables in the severely adverse scenario, the Board will consider the following scenario design principles:
(1) Severity: The scenarios should be sufficiently severe. Severity is an important component in ensuring that covered companies are adequately capitalized against a hypothetical severe recession and in maintaining the public credibility of stress tests. In determining the adequate level of severity for these guides, the principle of severity requires that, at times, variable paths may exceed levels observed in the historical data. Since no single scenario can account for all potential contingencies, the scenario must be sufficiently severe to ensure that banks will be resilient to a range of alternative and plausible scenarios that could generate net losses that are of similar magnitudes, even if such scenarios would have different characteristics from the single annual scenario. In establishing a sufficiently severe scenario, the Board considers the potential unintended effects of the scenario on the operations of firms subject to the stress tests.
(2) Credibility: The scenarios should be credible. Credible stress tests maintain the confidence of the public and financial markets that the stress tests are sufficiently severe to ensure that the firms are properly capitalized to withstand severe economic and financial conditions.
(3) Avoiding adding procyclicality: The scenarios should avoid adding sources of procyclicality. If stress tests are relatively more severe in already stressed conditions, then this severity could add undue stress to the financial system, reducing financial intermediation with negative implications for the macroeconomy. The stress tests should balance the need for an adequately severe scenario without unduly magnifying existing procyclical tendencies in the financial system.
(4) Flexibility: While the Board's scenario design framework promotes transparency and predictability, fixed paths often would fail to achieve at least one of the Board's goals of severity, credibility, and not adding to procyclicality, as well as the principles established in the Board's Stress Testing Policy Statement.13 As a result, the Board has designed guides in this section that generally establish ranges of historically observed values that can be selected for a given severely adverse scenario. At the same time, the scenario design framework enables the Board to consider testing unexpected shocks that may have implications for the economy and the financial stability of the United States, and therefore, firms' future financial condition, even if these shocks could exceed historically observed values. Further, flexibility is important to enable the Board to implement reasonable technical adjustments to the values and trajectories of the variables, consistent with these scenario design principles.
(g) The guides described in this section set out paths for each variable until it reaches its peak/trough in the severely adverse scenario. The stress test requires projections of 13 quarters' worth of losses to determine capital ratios at the end of 9 quarters of the scenario, because loss provisions in quarter 9 are affected by bank performance in quarters 10 to 13. To describe these paths, most guides adopt a simple framework involving the following 4 parameters:
(1) The jump-off value: the value of the variable in the quarter preceding the scenario. The jump-off value will be set to reflect the conditions at the time that the scenario is designed.
(2) The peak or trough value: the paths in each guide specify that each variable in the scenario will either increase or decrease from its jump-off value. If the variable increases, it will reach a maximum or peak value during the scenario. If it decreases, it will reach a minimum or trough value during the scenario.
(3) The timing of the peak or trough: the quarter of the scenario in which the variable path reaches its peak or trough.
(4) The trajectory from jump-off to peak or trough: the values between the jump-off and peak or trough will be determined with a roughly linear interpolation, a nonlinear function, or by specifying the proportion of the change from jump-off to peak or trough that will obtain in each of the intervening quarters.
(h) The severely adverse scenario will also set out end values and trajectories to end values. The end value is expected to generally be consistent with the historical values of a given variable within a 10 to 15 quarter window after the beginning of either a recession or other identified stress event. The trajectory from peak or trough to end value is expected to generally be determined by a roughly linear interpolation. The trajectory from the peak or trough to the end value generally will be smooth for variables determined by guides and follow the model path for modeled variables.
4.2.2.1 Setting the Unemployment Rate Under the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature an unemployment rate peak value that increases between 3 to 5 percentage points from its jump-off value. However, if a 3 to 5 percentage point increase in the unemployment rate does not raise the level of the unemployment rate to at least 10 percent, the path of the unemployment rate in most cases will be specified so as to raise the unemployment rate to at least 10 percent.
(b) The Board anticipates that the unemployment rate peak value will occur between quarters 6 and 8 after the jump-off point for the scenario. The trajectory to peak value is expected to experience high initial changes with smaller subsequent changes quarter to quarter.
4.2.2.2 Setting House Prices in the Severely Adverse Scenario
(a) In specifying the path for nominal house prices, the Board will consider the ratio of the nominal house price index (HPI) to nominal per capita DPI. The Board anticipates that the severely adverse scenario will feature an HPI–DPI ratio that falls (1) by at least 25 percent, or (2) by enough to bring the ratio down to the trough reached in the first quarter of 2012 after the 2007–2009 financial crisis.
(b) The trough is expected to occur between quarter 8 and quarter 10 after the jump-off quarter. The trajectory to trough value is expected to experience 20 percent of the decline realized in quarter 1 and another 20 percent of the decline in quarter 2 (40 percent in total), with a roughly linear trajectory to trough thereafter.
4.2.2.3 Setting the BBB Spread for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature a BBB corporate spread value, defined as the difference between the yield on BBB corporate bonds and the 10-year Treasury yield, that increases to the higher of (1) between a spread level of 500 to 600 basis points, or (2) a total increase of about 100 basis points from the jump-off value.
(b) The Board anticipates that the BBB spread peak value will occur between quarters 3 and 4 after the jump-off point for the scenario. The trajectory to peak value is expected to experience the highest share of the increase in quarters 1 and 2, with between 60 and 80 percent of the increase in quarter 1, followed by a smooth trajectory to peak thereafter.
4.2.2.4 Setting the Mortgage Rate Spread for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature a mortgage rate spread value, relative to the 10-year Treasury yield, that will be set based on the conditions at the time that the scenario is designed. The Board anticipates that the severely adverse scenario will increase to the higher of (1) between a 70 to 160 basis point increase in the mortgage rate spread, or (2) increase to a level of at least 300 basis points.
(b) The Board anticipates that the mortgage rate spread peak value will occur between quarters 3 and 4 after the jump-off point for the scenario. The trajectory to peak value is expected to experience between 50 and 70 percent of the increase realized in quarter 1, with a smooth trajectory to peak thereafter.
4.2.2.5 Setting the VIX for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature a VIX peak value that will increase to the higher of (1) between 65 and 75 percent or (2) by at least 10 percentage points from the jump-off value.
(b) The Board anticipates that the VIX peak value will occur in quarter 2 after the jump-off point for the scenario. The trajectory to peak value is expected to experience the largest share of the increase, of 60 to 80 percent, in quarter 1.
4.2.2.6 Setting Equity Prices for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature an equity price value that falls by around 50 percent plus or minus up to 10 percent, depending on the performance of equity prices over the 12-month period prior to the jump-off value. When equity prices have risen over the past 12 months, equity prices will fall to a trough level below the jump-off value of 50 percent plus one half of the percentage increase in equity prices up to a maximum of 10 percent. When equity prices have decreased over the past 12 months, equity prices will fall to a trough level below the jump-off value of 50 percent minus one half of the percentage decrease in equity prices, up to a maximum of 10 percent. Thus, the equity prices reach a trough level of between 40 and 60 percent below the jump-off value.
(b) The Board anticipates that the equity price trough value will occur in quarter 3 or 4 after the jump-off point for the scenario. The trajectory to trough value is expected to experience the highest share of the decrease, 60 to 70 percent, in quarter 1, with 10 to 20 percent of the decline occurring in quarter 2 and the remaining decline realized about equally in the remaining quarter(s) to the trough value.
4.2.2.7 Setting CRE Prices for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature a CRE price value that falls between 30 and 45 percent from its jump-off value.
(b) The Board anticipates that the CRE trough value will occur between 8 and 10 quarters after the jump-off value for the scenario. The trajectory to trough value is expected to be roughly linear.
4.2.2.8 Setting the 5-Year Treasury Yield for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature a 5-year Treasury yield value that falls to the lower of (1) between 1.5 and 3.5 percentage points from its jump-off value, subject to a lower bound of 0.3 percent, or (2) a decline of 0.3 percent from the jump-off level.
(b) The Board anticipates that the 5-year Treasury yield trough value will occur between 1 and 4 quarters after the jump-off value for the scenario. The trajectory to trough value is expected to experience the highest share of the decrease in quarter 1, depending on the quarter that the trough value will occur, such that the share of the decrease in quarter 1 will be between 55 percent and 100 percent. If the trough value is set to occur in quarters 2, 3, or 4, the yield decline trajectory following quarter 1 will decrease smoothly to the trough quarter.
4.2.2.9 Setting the 10-Year Treasury Yield for the Severely Adverse Scenario
(a) The Board anticipates that the severely adverse scenario will feature a 10-year Treasury yield value that falls to the lower of (1) between 1 and 3 percentage points from its jump-off value, subject to a lower bound of 0.5 percent, or (2) a decline of 0.3 percent from the jump-off level.
(b) The Board anticipates that the 10-year Treasury yield trough value will occur between 1 and 4 quarters after the jump-off value for the scenario. The trajectory to trough value is expected to experience the highest share of the decrease in quarter 1, depending on the quarter that the trough value will occur, such that the share of the decrease in quarter 1 will be between 55 percent and 100 percent. If the trough value is set as quarters 2, 3, or 4, the yield decline trajectory following quarter 1 will decrease smoothly to the trough quarter.
4.2.2.10 Setting the Calibration of International Variables
(a) The Board expects to calibrate values for certain international variables in the euro area, the United Kingdom, Japan, and Developing Asia.
(b) For the euro area, the Board expects in general to specify that GDP will decline by 7.5 percent from the baseline value to its trough in the scenario, and reach an end value of 7.5 percent below the baseline value. However, the Board may choose a value for the decline in GDP between 5 and 10 percent. The Board expects to specify that euro area inflation will decline by 3 percentage points from the baseline scenario to its trough, and reach an end value of 0 percentage points below the baseline value. However, the Board may choose a value for the decline in inflation between 2 and 4 percentage points. The Board expects to specify that the U.S. dollar will appreciate against the euro by approximately 15 percent from its jump-off value at its peak and then revert back to the jump-off value by the end of the scenario. However, the Board may choose a value for U.S. dollar appreciation between 5 and 25 percent.
(c) For the United Kingdom, the Board expects in general to specify that GDP will decline by 7.5 percent from the baseline value to its trough in the scenario, and reach an end value of 7.5 percent below the baseline value. However, the Board may choose a value for the decline in GDP between 5 and 10 percent. The Board expects to specify that inflation will decline by 3 percentage points from the baseline value to its trough, and reach an end value of 0 percentage points below the baseline value. However, the Board may choose a value for the decline in inflation between 2 and 4 percentage points. The Board expects to specify that the U.S. dollar will appreciate against the Great Britain Pound by 15 percent from its jump-off value at its peak and then revert back to the jump-off value by the end of the scenario. However, the Board may choose a value for U.S. dollar appreciation between 5 and 25 percent.
(d) For Japan, the Board expects in general to specify that GDP will decline by 7.5 percent from the baseline value to its trough in the scenario, and reach an end value of 7.5 percent below the baseline value. However, the Board may choose a value for the decline in GDP between 5 and 10 percent. The Board expects to specify that inflation will decline by 3 percentage points from the baseline value to its trough, and reach an end value of 0 percentage points below the baseline value. However, the Board may choose a value for the decline in inflation between 2 and 4 percentage points. The Board expects to specify that the U.S. dollar will depreciate against the Japanese yen by 1 percent from its jump-off value at its peak and then revert back to the jump-off value by the end of the scenario. However, the Board may choose a value for change in value of the U.S. dollar against the Japanese yen ranging from a 9 percent depreciation to an 11 percent appreciation.
(e) For Developing Asia, the Board expects in general to specify that GDP will decline by 3 percent from the baseline value to its trough, and reach an end value of 0 percent below the baseline value. However, the Board may choose a value for the decline in GDP between 0.5 and 5.5 percent. The Board expects to specify that inflation will decline by 5 percentage points from the baseline value to its trough, and reach an end value of 0 percentage points below the baseline value. However, the Board may choose a value for the decline in inflation between 0.8 and 9 percentage points. The Board expects to specify that the U.S. dollar will appreciate against the currencies in Developing Asia by 15 percent from its jump-off value at its peak and then revert back to the jump-off value by the end of the scenario. However, the Board may choose a value for the appreciation of the U.S. dollar between 5 and 25 percent.
4.2.3 Adding Salient Risks to the Severely Adverse Scenario
(a) The severely adverse scenario will be developed to reflect specific risks to the economic and financial outlook that are especially salient but that would feature minimally in the scenario if the Board were to use only approaches that looked to past recessions or relied on historical relationships between variables.
(b) There are some important instances in which it will be appropriate to augment the recession approach with salient risks. For example, if an asset price were especially elevated and thus potentially vulnerable to an abrupt and potentially destabilizing decline, it would be appropriate to include such a decline in the scenario even if such a large drop were not typical in a severe recession. Likewise, if economic developments abroad were particularly unfavorable, assuming a weakening in international conditions larger than what typically occurs in severe U.S. recessions would likely also be appropriate.
(c) While the recession component of the severely adverse scenario is within some predictable range, the salient risk aspect of the scenario is far less so, and therefore, needs an annual assessment. As appropriate, the Board will identify the risks to the financial system and the domestic and international economic outlooks that appear more elevated than usual, using its internal analysis and supervisory information and in consultation with the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC). Using the same information, the Board will then calibrate the paths of the macroeconomic and financial variables in the scenario to reflect these risks.
(d) The Board will factor in particular risks to the domestic and international macroeconomic outlook identified by its economists, bank supervisors, and financial market experts and make appropriate adjustments to the paths of specific economic variables. These adjustments will not be reflected in the general severity of the recession and, thus, all macroeconomic variables; rather, the adjustments will apply to a subset of variables to reflect co-movements in these variables that are historically less typical. The Board plans to discuss the motivation for the adjustments that it makes to variables to highlight systemic risks in the narrative describing the scenarios, which will be released for public comment and subsequently adjusted, if necessary, in response to those comments.14
5. Approach for Formulating the Market Shock Component
(a) This section discusses the approach the Board proposes to adopt for developing the market shock component of the severely adverse scenario appropriate for companies with significant trading activities. The design and specification of the market shock component differs from that of the macroeconomic scenarios because profits and losses from trading are measured in mark-to-market terms, while revenues and losses from traditional banking are generally measured using the accrual method. As noted above, another critical difference is the time-evolution of the market shock component. The market shock component consists of a sudden ''shock'' to a large number of risk factors that determine the mark-to-market value of trading positions, while the macroeconomic scenarios supply a projected path of economic variables that affect traditional banking activities over the entire planning period.
(b) The development approaches for the market shock component that are detailed in this section are as follows: baseline (subsection 5.1) and severely adverse (subsection 5.2).
5.1 Approach for Formulating the Market Shock Component Under the Baseline Scenario
Market shocks are large, previously unanticipated moves in asset prices and rates. Under the baseline scenario, asset prices should, broadly speaking, reflect consensus opinions about the future evolution of the economy. Sudden price movements, as envisioned in the market shock, should not occur along the baseline path. As a result, the market shock will not be included in the baseline scenario.
5.2 Approach for Formulating the Market Shock Component Under the Severely Adverse Scenario
This section addresses possible approaches to designing the market shock component in the severely adverse scenario, including important considerations for scenario design, possible approaches to designing scenarios, and a development strategy for implementing the preferred approach.
5.2.1 Design Considerations for Market Shocks
(a) The general market practice for stressing a trading portfolio is to specify market shocks either in terms of changes to observable, broad financial market indicators and risk factors or directly as changes to the mark-to-market values of financial instruments.
(b) While the number of market shocks used in companies' pricing and stress-testing models typically exceeds that provided in the Board's scenarios, the number of market shocks in the Board's scenarios allows for the consistency and comparability of market losses across companies. However, the benefit from specifying a large set of market shocks is at least partly offset by the potential difficulty in creating shocks that are coherent and internally consistent, particularly as the framework for developing market shocks deviates from historical events. The Board's process for generating the scenario market shocks has developed over time to rely less on models and has expanded its use of simpler methods, such as multipliers and mappings to modeled risk factors.
(c) Also, importantly, the ultimate losses associated with a given market shock will depend on a company's trading positions, which can make it difficult to rank order, ex ante, the severity of the scenarios. In certain instances, market shocks that include large market moves may not be particularly stressful for a given company. Aligning the market shock with the macroeconomic scenario for consistency may result in certain companies actually benefiting from risk factor moves of larger magnitude in the market scenario if the companies are hedging against salient risks to other parts of their business. Thus, the severity of market shocks must be calibrated to take into account how a complex set of risks, such as directional risks and basis risks, interacts with each other, given the companies' trading positions at the time of stress. For instance, a large depreciation in a foreign currency would benefit companies with net short positions in the currency while hurting those with net long positions. In addition, longer maturity positions may move differently from shorter maturity positions, adding further complexity.
(d) The sudden nature of market shocks and the early recognition of mark-to-market losses add another element to the design of market shocks, and to determining the appropriate severity of shocks. The design of the market shocks must factor in appropriate assumptions around the period of time during which market events will unfold and any associated market responses.
(e) The design of market shocks includes calibration of shock magnitudes based on assumed time horizons that reflect several scenario design considerations. One consideration is the liquidity characteristics of different asset classes. More specifically, the calibration horizons reflect the variation in speed at which banks could reasonably close out, or effectively hedge, the associated risk exposures in the event of a market stress. The horizons are generally longer than the typical times needed to liquidate exposures under normal conditions because they are designed to capture the unpredictable liquidity conditions that prevail in times of stress. Another consideration is maintaining consistency between the assumed time horizons used to calibrate market shocks and the timeline for attributing the losses stemming from them. Specifically, losses associated with the global market shock component are attributed in one quarter of the stress test horizon, which implies an upper bound of three months for calibrating the shocks.
(f) Given these considerations, shock liquidity horizons are chosen to be broadly consistent with the standards in the Fundamental Review of the Trading Book (FRTB). The horizons in the FRTB are specified based on recommendations from consultations with the financial industry and its regulators. The horizons in the FRTB are therefore considered a reasonable benchmark for defining the shock horizons used in the global market shock. The liquidity horizons used in the market shock scenarios are not expected to be perfectly matched with the FRTB liquidity horizons due to granularity differences between the FRTB standards and the global market shock template. The FRTB specifies horizons at a more granular level, often using different horizons within each asset class, whereas the Board uses the same liquidity horizon for all market shocks within each asset class. Given these differences, the global market shock scenario aims to align with the horizons specified by the FRTB by using a weighted average of the FRTB horizons within each asset class. The weights are determined using aggregate firm exposures. For example, FRTB horizons for equity risk factors vary between 10 and 60 business days, and the global market shock horizon for this asset class is assumed to be 4 weeks. Because the Board imposes an upper bound on global market shock horizons of one quarter, there are cases where in which the range of FRTB horizons is longer than the global market shock horizon. For example, FRTB horizons for corporate credit market shocks vary between 60 and 120 business days, but the Board uses a horizon of 3 months for corporate credit.
5.2.2 Approaches to Market Shock Design
(a) As an additional component of the severely adverse scenario, the Board plans to use a standardized set of market shocks that apply to all companies with significant trading activity. The market shocks could be based on a single historical episode, hypothetical (but plausible) events, or some combination of historical episodes, with or without the addition of-hypothetical events (hybrid approach). Depending on the type of hypothetical events, a scenario based on such events may result in changes in risk factors that were not previously observed.
(b) For the market shock component in the severely adverse scenario, the Board plans to use the hybrid approach to develop shocks. The hybrid approach allows the Board to maintain certain core elements of consistency in market shocks each year while providing flexibility to add hypothetical elements based on market conditions at the time of the stress tests. In addition, this approach will help ensure internal consistency in the scenario because of its basis in historical episodes; however, combining the historical episode and hypothetical events may require some adjustments to ensure mutual consistency of the joint moves. In general, the hybrid approach provides considerable flexibility in developing scenarios that are relevant each year, and by introducing variations in the scenario, the approach will also reduce the ability of companies with significant trading activity to modify or shift their portfolios to minimize expected losses in the severely adverse market shock.
(c) The Board has considered a number of alternative approaches for the design of market shocks. For example, the Board explored an option of providing tailored market shocks for each trading company, using information on the companies' portfolios gathered through ongoing supervision, or other means. By specifically targeting known or potential vulnerabilities in a company's trading position, the tailored approach would be useful in assessing each company's capital adequacy as it relates to the company's idiosyncratic risk. However, the Board does not believe this approach to be well-suited for the stress tests required by regulation. Consistency and comparability are key features of annual supervisory stress tests and annual company-run stress tests required in the stress test rules. It would be difficult to use the information on the companies' portfolios to design a common set of shocks that are universally stressful for all covered companies. As a result, this approach would be better suited to more customized, tailored stress tests that are part of the company's internal capital planning process or to other supervisory efforts outside of the stress tests conducted under the capital rule and the stress test rules.
5.2.3 Development of the Market Shock
(a) Consistent with the approach described above, the market shock component for the severely adverse scenario will incorporate key elements of market developments during historical periods of stress, and may include other price and rate movements in certain markets that the Board deems to be plausible, though such movements may not have been observed historically.
(b) The Board will identify potential market stress scenarios, based on multiple sources of information, including financial stability reports, supervisory information, and internal and external assessments of market risks and potential flash points. The hypothetical elements could originate from major geopolitical, economic, or financial market events with potentially significant impacts on market risk factors. The severity of these hypothetical moves will likely be guided by similar historical events, assumptions embedded in the companies' internal stress tests or market participants, and other available information.
(c) Once broad market scenarios are agreed upon, the implications for key risk factor groups will be defined. For example, a scenario involving the failure of a large, interconnected globally active financial institution could begin with a sharp increase in credit default swap spreads and a precipitous decline in asset prices across multiple markets, as investors become more risk averse and market liquidity evaporates. These broad market movements will be extrapolated to the granular level for all risk factors by examining transmission channels and the historical relationships between variables, though in some cases, the movement in particular risk factors may be amplified based on theoretical relationships, market observations, or the saliency to company trading books. If there is a disagreement between the risk factor movements in the historical event used in the scenario and the hypothetical event, the Board will reconcile the differences by assessing a priori expectations based on financial and economic theory and the importance of the risk factors to the trading positions of the firms.
6. Consistency between the Macroeconomic Scenarios and the Market Shock
(a) As discussed earlier, the market shock comprises a set of movements in a large number of risk factors that are realized in the first quarter of the stress test horizon. Among the risk factors specified in the market shock are several variables also specified in the macroeconomic scenarios, such as short- and long-maturity interest rates on Treasury and corporate debt, the level and volatility of U.S. stock prices, and exchange rates.
(b) The market shock component is an add-on to the macroeconomic scenarios that reflects abrupt market disruptions. As a result, the market shock component may not always be directionally consistent with the macroeconomic scenario. Because the market shock is designed, in part, to mimic the effects of a sudden market dislocation, while the macroeconomic scenarios are designed to provide a description of the evolution of the real economy over two or more years, assumed economic conditions can move in significantly different ways. In effect, the market shock can simulate a market panic, during which financial asset prices move rapidly in unexpected directions, and the macroeconomic assumptions can simulate the severe recession that follows. Indeed, the pattern of a financial crisis, characterized by a short period of wild swings in asset prices followed by a prolonged period of moribund activity, and a subsequent severe recession is familiar and plausible.
(c) As discussed in section 4.2.3, the Board may feature a particularly salient risk in the macroeconomic assumptions for the severely adverse scenario, such as a fall in an elevated asset price. In such instances, the Board may also seek to reflect same risk in the market shock. For example, if the macroeconomic scenario were to feature a substantial decline in house prices, it may be plausible for the market shock to feature a significant decline in market values of any securities that are closely tied to the housing sector or residential mortgages.
7. Timeline for Scenario Publication
(a) The Board will provide a final description of the macroeconomic scenarios by no later than February 28. During the period immediately preceding the publication of the scenarios, the Board will collect and consider information from academics, professional forecasters, international organizations, domestic and foreign supervisors, and other private-sector analysts that regularly conduct stress tests based on U.S. and global economic and financial scenarios, including analysts at the firms. In addition, the Board will consult with the FDIC and the OCC on setting the guides in the scenarios. The Board expects to conduct this process each year and disclose the developed scenarios for public comment. The Board will update the scenarios, based on the public comments and incoming macroeconomic data releases and other information.
(b) The Board expects to provide a broad overview of the market shock component along with the macroeconomic scenarios. The Board will publish the market shock templates by no later than March 1 of each year.
| Peak | Trough | Severity | Duration (quarters) |
Decline in real GDP |
Change in the unemployment rate during the recession |
Total change in the unemployment rate (incl. after the recession) |
| 1957Q3
|
1958Q2
|
Severe
|
4 (Medium)
|
−3.0 | 3.2 | 3.2 |
| 1960Q2
|
1961Q1
|
Moderate
|
4 (Medium)
|
−0.1 | 1.6 | 1.8 |
| 1969Q4
|
1970Q4
|
Moderate
|
5 (Medium)
|
−0.2 | 2.2 | 2.4 |
| 1973Q4
|
1975Q1
|
Severe
|
6 (Long)
|
−3.1 | 3.5 | 4.1 |
| 1980Q1
|
1980Q3
|
Moderate
|
3 (Short)
|
−2.2 | 1.4 | 1.4 |
| 1981Q3
|
1982Q4
|
Severe
|
6 (Long)
|
−2.5 | 3.3 | 3.3 |
| 1990Q3
|
1991Q1
|
Mild
|
3 (Short)
|
−1.4 | 0.9 | 1.9 |
| 2001Q1
|
2001Q4
|
Mild
|
4 (Medium)
|
0.5 | 1.3 | 1.9 |
| 2007Q4
|
2009Q2
|
Severe
|
7 (Long)
|
−3.8 | 4.5 | 5.1 |
| 2019Q4
|
2020Q2
|
Severe
|
2 (Short)
|
−9.2 | 9.4 | 9.4 |
| Average
|
|
Severe
|
6
|
−3.5 | 5 | 3.9 |
| Average
|
|
Moderate
|
4
|
−1.1 | 1.7 | 1.9 |
| Average
|
|
Mild
|
3
|
−0.6 | 1.1 | 1.9 |
Source: Bureau of Economic Analysis, National Income and Product Accounts and Bureau of Labor Statistics.
Note: (1) Peak refers to a peak quarter of the business cycle as defined by the NBER US Business Expansions and Contractions; (2) Trough refers to a trough quarter of the business cycle as defined by the NBER US Business Cycle Expansions and Contractions; (3) There is no universal agreement on how to categorize recession severity. For the purposes of this table, the following categorization is employed: Recessions where the decline in real GDP or the increase in the unemployment rate are less than 1.5 percent or 1.5 percentage points, respectively, are considered mild; recessions where the decline in real GSP is 2.5 percent or more, or the increase in the unemployment rate is 3 percentage points or more, are considered severe; all other recessions are considered moderate; (4) Recession duration is categorized as follows: <4 quarters, short; 4–5 quarters, medium; >5 quarters, long; (5) Real GDP is real GDP adjusted for inflation from the Bureau of Economic Analysis (National Income and Products Accounts table 1.1.6, line 1); (6) Unemployment rate is the quarterly average of seasonally adjusted monthly unemployment rates for the civilian, non-institutional population aged 16 years and older from Bureau of Labor Statistics (series LNS14000000); (7) Total change in the unemployment rate (incl. after the recession) calculates the difference between the maximum unemployment rate achieved during the NBER-defined recession period or the subsequent six quarters and the value of the unemployment rate during the peak quarter.
| Table 2—House Prices in Housing Recessions | ||||||
| Peak | Trough | Severity | Duration (quarters) |
%- change in NHPI |
%-change in HPI-DPI |
HPI-DPI trough level (2000:Q1 = 100) |
| 1980Q2
|
1985Q2
|
Moderate
|
19 (Long)
|
24.2 | −13.1 | 100.2 |
| 1989Q4
|
1997Q1
|
Moderate
|
30 (Long)
|
12.5 | −16.8 | 93.6 |
| 2005Q4
|
2012Q1
|
Severe
|
25 (Long)
|
−28.7 | −40.4 | 89.5 |
| Average
|
|
|
24.7
|
2.7 | −23.4 | 94.4 |
Source: CoreLogic, Bureau of Economic Analysis.
Note: The date-ranges of housing recessions listed in Table 2 are based on the timing of house-price retrenchments.
1
12 U.S.C. 5365(i)(1); subpart E of this part.
2
12 U.S.C. 5365(i)(2); subparts B and F of this part.
3
The stress test rules define scenarios as those sets of conditions that affect the United States economy or the financial condition of a company that the Board determines are appropriate for use in stress tests, including, but not limited to, baseline and severely adverse scenarios. The stress test rules define baseline scenario as a set of conditions that affect the United States economy or the financial condition of a company and that reflect the consensus views of the economic and financial outlook. The stress test rules define severely adverse scenario as a set of conditions that affect the U.S. economy or the financial condition of a company and that overall are significantly more severe than those associated with the baseline scenario and may include trading or other additional components.
4
Sections 252.14(b); 252.44(b); 252.54(b).
5
See section 225.8.
6
Sections 252.14(a); 252.44(a); 252.54(a).
7
Sections 252.14(b); 252.44(b); 252.54(b).
8
The future path of a variable refers to its specification over a given time period. For example, the path of unemployment can be described in percentage terms on a quarterly basis over the stress testing time horizon.
9
The Board may increase the range of countries or regions included in future scenarios, as appropriate.
10
Currently, companies with significant trading activity include any bank holding company or intermediate holding company that (1) has aggregate trading assets and liabilities of $50 billion or more, or aggregate trading assets and liabilities equal to 10 percent or more of total consolidated assets, and (2) is not a Category IV firm. The Board may also subject a state member bank subsidiary of any such bank holding company to the market shock component. The set of companies subject to the market shock component could change over time as the size, scope, and complexity of the covered company's trading activities evolve.
11
More recently, a monthly measure of GDP has been added to the list of indicators.
12
Even though all recessions feature increases in the unemployment rate and contractions in incomes and economic activity, the size of this change has varied over post-war U.S. recessions. Table 1 documents the variability in the depth of post-war U.S. recessions. Some recessions—labeled mild in Table 1—have been relatively modest, with GDP declining less than one percent and the unemployment rate moving up about a percentage point on average. Other recessions—labeled severe in Table 1—have been much harsher, with GDP dropping 3.75 percent and the unemployment rate moving up a total of about 4 percentage points.
13
Appendix B to this part.
14
The means of effecting an adjustment to the severely adverse scenario to address salient systemic risks differs from the means used to adjust variables within the ranges specified by the guides or the paths suggested by the macroeconomic model. For example, in adjusting the scenario for an increased unemployment rate, the Board would modify all variables such that the future paths of the variables would be similar to how these variables have moved historically in response to a change in the unemployment rate. In contrast, to address salient risks, the Board may only modify a small number of variables in the scenario and, as such, their future paths in the scenario would be somewhat more atypical, but not implausible, given existing risks.