Board of Governors of the Federal Reserve System

Appendix A: Model Changes for the 2025 Stress Test

Each year, the Federal Reserve refines both the substance and process of the stress test, including its development and enhancement of independent supervisory models. The supervisory stress test models may be enhanced to reflect advances in modeling techniques; enhancements in response to model validation findings; incorporation of richer and more detailed data; and identification of more stable models or models with improved performance, particularly under stressful economic conditions. Each year, the Federal Reserve also makes relatively minor refinements, if necessary, to models that may include re-estimation with new data, re-specification based on performance testing, and other refinements to the code used to produce supervisory projections. The changes described here are incorporated in the model descriptions provided earlier in the document.

For the 2025 stress test, the Federal Reserve has made the following notable updates to the supervisory models:¹²²

• Total compensation is composed of salaries, variable compensation, and employee benefits. For the 2024 stress test, the Federal Reserve implemented a model adjustment to explicitly condition the projections of compensation expenses on the share of cash variable compensation.¹²³ This year, the Federal Reserve expanded this adjustment to include commissions. This enhancement is intended to account for heterogeneity of business lines and compensation practices across firms.
• Private equity exposures were removed from the global market shock component of the stress test. Instead, losses on these exposures are projected under the macroeconomic scenario. This change better aligns with the characteristics of private equity exposures, which are principally long-term investments that are managed as banking book positions. For more information on the Federal Reserve's approach to modeling private equity, see the "Private Equity" subsection in "Descriptions of Supervisory Models."

Additionally, three changes that were already introduced as adjustments to the 2024 stress test are fully implemented for the 2025 stress test.¹²⁴

• In the 2025 stress test, the model for interest income and expenses related to "federal funds and repurchase agreements" was updated to be based on balances multiplied by the path of the 3-month Treasury rate under the macroeconomic scenario to improve the comparability of results across firms. These components were previously modeled using a panel autoregressive framework.
• The "all other" interest expense component was incorporated into the model for interest expense from trading liabilities and other borrowed money to improve the comparability of results across firms. Previously, it was modeled as a separate component.
• The model used to calculate the PD on CRE loans is a function of various loan characteristics. For the 2025 stress test, the CRE PD model was adjusted for loans that approach maturity with a low DSCR during the projection horizon.¹²⁵ The adjustment accounts for the effect of interest rate risk on the refinancing of CRE loans as a low DSCR serves as an indicator of a CRE borrower's ability to make interest payments.

In addition, an assessment based on ongoing model monitoring and targeted data collected through special collections will inform whether any other model adjustments are warranted in the 2025 stress test. The Board will provide descriptions of any additional model adjustments made for the 2025 stress test in the 2025 stress test results disclosure.¹²⁶

 

References

 

 122. In accordance with the stress test policy on averaging material model changes, the model change related to compensation expenses will be phased in over the 2025 and 2026 stress test cycles. The remaining model changes are not material and so will be implemented in full for the 2025 stress test. Return to text

 123. See Board of Governors of the Federal Reserve System, 2024 Stress Test Results (Washington: Board of Governors, June 2024), https://www.federalreserve.gov/publications/files/2024-dfast-results-20240626.pdf. Return to text

 124. See Board of Governors of the Federal Reserve System, 2024 Stress Test Results (Washington: Board of Governors, June 2024), https://www.federalreserve.gov/publications/files/2024-dfast-results-20240626.pdf. Return to text

 125. The debt service coverage ratio is the ratio of a CRE property's net operating income to its debt payments. Return to text

 126. Consistent with past practice, the Federal Reserve will disclose any significant model adjustments that permanently change the models in a future methodology disclosure. Return to text