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Figure 1. How stress testing works for large banks
Caption: The Federal Reserve conducts stress tests to ensure that large banks are sufficiently capitalized and able to lend to households and businesses even in a severe recession. The stress tests evaluate the financial resilience of banks by estimating losses, revenues, expenses, and resulting capital levels under hypothetical recession scenarios.
In this infographic, there are three arrows on the left side that are facing to the right.
The first arrow says, "The Federal Reserve develops stress test scenarios."
The second arrow says, "The Federal Reserve develops or selects stress test models."
The third arrow says, "Banks submit detailed bank data."
The arrows are pointing to box in the middle of the figure that says, "Using the scenario data and bank data as variables in the stress test models, the Federal Reserve projects how banks are likely to perform under a hypothetical recession."
The middle box is pointing to a box on the right side that says, "The Federal Reserve uses the results of the supervisory stress test, in part, to set capital requirements for participating banks."
Figure 2. Projecting net income and regulatory capital
A flowchart with five boxes, leading from the top box to the bottom box.
Top first box, Net interest income plus noninterest income, minus noninterest expense, equals pre-provision net revenue (PPNR).1
Second box, PPNR plus other revenue, minus provisions for credit losses2, minus available-for-sale and held-to-maturity securities losses2, minus other losses/gains3, minus trading and counterparty losses, equals pre-tax net income.
Third box, Pre-tax net income minus taxes minus income attributable to minority interest minus change in the valuation allowance equals after-tax net income.
Fourth box, After-tax net income, minus payments on non-common capital, plus other comprehensive income, equals change in equity capital.
Bottom fifth box, Change in equity capital minus change in adjustments and deductions from regulatory capital, plus other additions to regulatory capital, equals change in regulatory capital.
Note 1: PPNR includes income from mortgage servicing rights and losses from operational-risk events and other real-estate-owned (OREO) costs. Return to text
Note 2: For firms that have adopted ASU 2016-13, the Federal Reserve incorporates its projection of expected credit losses on securities in the allowance for credit losses, in accordance with Financial Accounting Standards Board (FASB), Financial Instruments–Credit Losses (Topic 326), FASB Accounting Standards Update (ASU) 2016-13 (Norwalk, Conn.: FASB, June 2016).
Change in the allowances for credit losses, plus net charge-offs, equals provisions for credit losses. Return to text
Note 3: Other losses/gains include losses on loans held-for-sale, loans measured under the fair-value option, and loan hedges. Return to text