Board of Governors of the Federal Reserve System

This year's stress test shows that large banks have sufficient capital to withstand a highly stressful scenario and meet their minimum capital ratios. While the severity of this year's stress test is similar to last year's, the test resulted in higher losses because bank balance sheets are somewhat riskier and expenses are higher. The goal of our test is to help ensure that banks have enough capital to absorb losses in a highly stressful scenario. This test shows that they do.

I will take some time to explain this year's stress test results, the factors driving the results, and what we've learned from the exercise.

This Year's Stress Test Results
Let me start by saying that this year's results show that under our stress scenario, large banks would take nearly $685 billion in total hypothetical losses yet still have considerably more capital than their minimum common equity requirements. This is good news and underscores the usefulness of the extra capital that banks have built in recent years above their minimum requirements. Because of that extra capital cushion, we expect that large banks would be able to continue extending credit to households and businesses during a time of financial stress.

The aggregate decline in the capital ratios for the banks in the test is 2.8 percent of risk-weighted assets. That is larger than the 2.5 percent decline in last year's test, but within the range of recent stress tests. That year-over-year change is the same as the year-over-year change from 2021 to 2022.¹ As in 2022, these larger losses may inform an increase in capital requirements.

Factors Driving the Results
So what is driving those results? This year's scenario is pretty similar to last year's.² So, it is not changes in the scenario driving the results. Rather, the three main factors driving this year's results were associated with changes in banks' balance sheets and should be familiar to anyone following the banking system. They are:

1. Substantial increases in banks' credit card balances, combined with higher delinquency rates, resulted in greater projected credit card losses. Large banks have sizable credit card businesses, so changes here can affect the stress test noticeably.³
2. Banks' corporate credit portfolios have become riskier, partly reflected in individual banks downgrading their own loans, resulting in higher projected corporate losses.⁴
3. Higher expenses and lower fee income in recent years have resulted in less projected net income to offset losses.⁵

What It Means
While the nature of these risks should be no surprise, one of the purposes of the stress test is to quantify them. In doing so, the stress test helps us better understand how these risks are evolving on bank balance sheets and, importantly, whether banks are sufficiently capitalized to withstand them during stress. The test quantified the risks associated with the three factors I previously outlined, which suggest required capital buffers should be larger.

Just like the financial system, the stress test is dynamic. As risks in the financial system change, the stress test will adjust. That is an important supplement to other static elements of our capital requirements, which are calibrated to account for a baseline level of risk across the entire economic cycle. Together, those different tools—the static baseline and dynamic buffer—are key to helping to ensure that banks are well capitalized in good and bad times.

Exploratory Analysis
We also conducted an exploratory analysis. We are not using the exploratory analysis to inform capital requirements. Rather, it will be used to deepen our understanding of supervisory issues.

This year's analysis includes two funding stresses to all of the banks tested and two trading book stresses to only the largest and most complex banks. The two funding stresses include a rapid repricing of deposits, consistent with banks responding to large potential outflows, combined with more severe and less severe recessions. Under each of the funding stresses, there would be aggregate capital ratio declines of 2.7 and 1.1 percentage points, respectively.

Under the two exploratory trading book stresses, which included the failure of five large hedge funds under different market conditions, the results demonstrated that the largest and most complex banks have material exposure to hedge funds but that those banks can withstand different types of trading book shocks. We will continue to explore bank exposures to hedge funds, based on what we learned.

Conclusion
While banks are well positioned to withstand the specific hypothetical recession we tested them against, the stress test also confirmed that there are some areas to watch. The financial system and its risks are always evolving, and we learned in the Great Recession the cost of failing to acknowledge shifting risks. The stress test is one of the key innovations to address those dynamic risks, and the results of this year's test demonstrate that the dynamism built into the stress test works as designed by picking up some increasing risks on bank books. The banking system is well positioned to deal with those risks. The exploratory scenarios also enable us to keep the stress test vibrant by continuing to explore new areas of risk.