Board of Governors of the Federal Reserve System

The Federal Reserve Board on Friday released the hypothetical scenarios for its 2021 bank stress tests. Last year, the Board found that large banks were generally well capitalized under a range of hypothetical events but due to continuing economic uncertainty placed restrictions on bank payouts to preserve the strength of the banking sector.

The Board's stress tests help ensure that large banks are able to lend to households and businesses even in a severe recession. The exercise evaluates the resilience of large banks by estimating their loan losses and capital levels—which provide a cushion against losses—under hypothetical recession scenarios that extend nine quarters into the future.

"The banking sector has provided critical support to the economic recovery over the past year. Although uncertainty remains, this stress test will give the public additional information on its resilience," Vice Chair for Supervision Randal K. Quarles said.

The hypothetical recession begins in the first quarter of 2021 and features a severe global downturn with substantial stress in commercial real estate and corporate debt markets. The U.S. unemployment rate in the "severely adverse" scenario rises by 4 percentage points from its starting point, reaching a peak of 10-3/4 percent in the third quarter of 2022. Gross domestic product falls 4 percent from the fourth quarter of 2020 through the third quarter of 2022, with asset prices dropping sharply, including a 55 percent decline in equity prices. The chart below shows the path of the unemployment rate:

This year, 19 large banks will be subject to the stress test. Smaller banks are on a two-year stress test cycle but can opt in to this year's test and must do so by April 5. Banks with large trading operations will be tested against a global market shock component that stresses their trading, private equity, and other fair value positions. Additionally, banks with substantial trading or processing operations will be tested against the default of their largest counterparty. A table below shows the components that would apply to each bank, as well as identifying which banks are on a two-year cycle, based on data as of September 30, 2020.

The scenarios are not forecasts and the severely adverse scenario is significantly more severe than most current baseline projections for the path of the U.S. economy under the stress testing period. They are designed to assess the strength of large banks during hypothetical recessions, which is especially appropriate in a period of uncertainty. Each scenario includes 28 variables covering domestic and international economic activity.