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Dodd-Frank Act Stress Test 2013: Supervisory Stress Test
Methodology and Results

Severely Adverse Scenario

On November 15, 2012, the Federal Reserve released three supervisory stress test scenarios: baseline, adverse, and severely adverse.11 This section describes the severely adverse scenario that is the basis for the projections contained in this report.

It is important to note that the severely adverse scenario is not a forecast, but rather a hypothetical scenario designed to assess the strength of banking organizations and their resilience to an adverse economic environment. The severely adverse scenario represents an outcome in which the U.S. economy experiences a significant recession and financial market stress, and economic activity in other major economies also contracts significantly.

The severely adverse scenario includes trajectories for 26 variables. These include 14 variables that capture economic activity, asset prices, and interest rates in the U.S. economy and financial markets and three variables (real GDP growth, inflation, and the U.S./foreign currency exchange rate) in each of four countries or country blocks (the euro area, the United Kingdom, developing Asia, and Japan).

Figures 2 through 6 illustrate the hypothetical trajectories for some of the key variables describing U.S. economic activity and asset prices as well as global economic growth under the severely adverse scenario. As the figures show, real GDP declines nearly 5 percent between the third quarter of 2012 and the end of 2013; over this period, the unemployment rate rises to 12 percent, and the four-quarter percent change in the consumer price index (CPI) decelerates to 1 percent. Equity prices fall more than 50 percent over the course of the recession and, correspondingly, the equity market volatility index jumps from about 21 in the third quarter of 2012 to more than 70 at the start of the scenario. House prices decline more than 20 percent by the end of 2014, and commercial real estate prices fall by a similar amount. The international component of the severely adverse scenario features recessions in the euro area, the United Kingdom, and Japan and below-trend growth in developing Asia.

The severely adverse scenario is similar in severity to the 2012 CCAR supervisory stress scenario.12 The main qualitative difference between this year's severely adverse scenario and last year's supervisory stress scenario is a much more substantial slowdown in developing Asia.

On November 19, 2012, the Federal Reserve provided six BHCs with large trading, private equity, and counterparty exposures from derivatives and financing transactions with a global market shock to include in their severely adverse scenario.13 The global market shock is a set of one-time, hypothetical shocks to a broad range of risk factors. Generally, these shocks involve large and sudden changes in asset prices, rates, and spreads, reflecting general market stress and heightened uncertainty.14

The global market shock is generally based on the price and rate movements that occurred in the second half of 2008, a period that featured severe market stress and the failure of a major, globally active financial institution. In addition, this global market shock incorporates hypothetical euro-zone-based shocks, including sharp increases in certain government yields, widening corporate spreads and sovereign credit default swap (CDS) spreads, and large depreciation of the euro against major currencies. Although these shocks are felt across the euro zone in the scenario, the severity of the shocks varies across countries within the euro zone, with more pronounced effects experienced by periphery countries.

Figure 2. Real GDP growth rate in the severely adverse scenario, Q1 2009-Q4 2015

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Source: Bureau of Economic Analysis and Federal Reserve assumptions in the severely adverse scenario.

Figure 3. Unemployment rate in the severely adverse scenario, Q1 2009-Q4 2015

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Source: Bureau of Labor Statistics and Federal Reserve assumptions in the severely adverse scenario.

Figure 4. Dow Jones Stock Market Index, end of quarter in the severely adverse scenario, Q1 2009-Q4 2015

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Source: Dow Jones and Federal Reserve assumptions in the severely adverse scenario.

Figure 5. National House Price Index in the severely adverse scenario, Q1 2009-Q4 2015

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Source: CoreLogic (seasonally adjusted by Federal Reserve) and Federal Reserve assumptions in the severely adverse scenario.

Figure 6. Real GDP growth in four country/country block areas in the severely adverse scenario, Q1 2009-Q4 2015

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Source: Federal Reserve calculations based on official sector sources and Federal Reserve assumptions in the severely adverse scenario. Q3 2012 data based on Federal Reserve calculations using available data as of November 13, 2012.


References

11. See Board of Governors of the Federal Reserve System (2012), "2013 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule" (Washington: Board of Governors, November 15), www.federalreserve.gov/newsevents/press/bcreg/20121115a.htm for additional information and for the details of the supervisory baseline and supervisory adverse scenarios. Return to text

12. The Federal Reserve CCAR 2012 macroeconomic scenarios were included in the "Federal Reserve System Comprehensive Capital Analysis and Review: Summary Instructions and Guidance," published November 22, 2011; see www.federalreserve.gov/newsevents/press/bcreg/20111122a.htmReturn to text

13. See 12 CFR 252.144(b)(2)(i). Return to text

14. See Board of Governors of the Federal Reserve System (2013), "Federal Reserve Board Announces Release Dates for Results from Supervisory Stress Tests and from the Comprehensive Capital Analysis and Review (CCAR)," press release (Washington: Board of Governors, January 28), www.federalreserve.gov/newsevents/press/bcreg/20130128a.htmReturn to text

Last update: March 28, 2013

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