Board of Governors of the Federal Reserve System

Executive Summary

The Dodd-Frank Act requires the Federal Reserve to conduct an annual stress test of BHCs with $100 billion or more in total consolidated assets, U.S. IHCs,⁶ and any nonbank financial company that the FSOC has determined shall be supervised by the Board.⁷ The Board first adopted rules implementing this requirement in October 2012 and most recently modified these rules in February 2017.⁸

For this year's stress test cycle (DFAST 2018), which began January 1, 2018, the Federal Reserve conducted supervisory stress tests of 35 firms.

This report provides

• background on Dodd-Frank Act stress testing;
• details of the adverse and severely adverse supervisory scenarios used in DFAST 2018;
• an overview of the analytical framework and methods used to generate the Federal Reserve's projections, highlighting notable changes from last year's program; and
• the results of the supervisory stress tests under adverse and severely adverse scenarios for the firms that participated in the DFAST 2018 program, presented both in the aggregate and for individual institutions.

The adverse and severely adverse supervisory scenarios used in DFAST 2018 feature U.S. and global recessions. In particular, the severely adverse scenario is characterized by a severe global recession in which the U.S. unemployment rate rises by almost 6 percentage points to 10 percent, accompanied by a global aversion to long-term fixed-income assets. The adverse scenario features a moderate recession in the United States, as well as weakening economic activity across all countries included in the scenario.

In conducting its supervisory stress tests, the Federal Reserve calculated its projections of each firm's balance sheet, risk-weighted assets (RWAs), net income, and resulting regulatory capital ratios under these scenarios using data on firms' financial conditions and risk characteristics provided by the firms and a set of models developed or selected by the Federal Reserve. For DFAST 2018, the Federal Reserve updated the calculation of projected capital to reflect changes in the tax code associated with the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017. As in past years, the Federal Reserve also enhanced some of the supervisory models to incorporate new data, where available, and to improve model stability and performance. The enhanced models generally exhibit an increased sensitivity to economic conditions compared to past years' models. These changes are highlighted in box 1. A description of modifications to the calculation of projected capital is included in box 2. A description of a recent proposal to increase the transparency of the supervisory stress test, including a notice of enhanced disclosure, is included in box 3. Specific descriptions of the supervisory models and related assumptions can be found in appendix B.

The results of the DFAST 2018 projections suggest that, in the aggregate, the 35 firms would experience substantial losses under both the adverse and the severely adverse scenarios but could continue lending to businesses and households, due to the substantial accretion of capital since the financial crisis.

Over the nine quarters of the planning horizon, which for DFAST 2018 begins in the first quarter of 2018 and ends in the first quarter of 2020, aggregate losses at the 35 firms under the severely adverse scenario are projected to be $578 billion. This includes losses across loan portfolios, losses from credit impairment on securities held in the firms' investment portfolios, trading and counterparty credit losses from a global market shock, and other losses. Projected aggregate pre-provision net revenue (PPNR) is $492 billion, and net income before taxes is projected to be −$139 billion.

In the severely adverse scenario, the aggregate Common Equity Tier 1 (CET1) capital ratio would fall from an actual 12.3 percent in the fourth quarter of 2017 to its minimum of 7.9 percent over the planning horizon. As illustrated in figure 1, the aggregate CET1 ratio is projected to rise to 8.7 percent by the end of the planning horizon.

In the adverse scenario, aggregate projected losses, PPNR, and net income before taxes are $333 billion, $467 billion, and $125 billion, respectively. The aggregate CET1 capital ratio under the adverse scenario would fall to its minimum of 10.9 percent over the planning horizon. Details of the results are provided in the Supervisory Stress Test Results section of this report.

 

References

 

 6. U.S. IHCs of foreign banking organizations are subject to the annual stress test in accordance with the transition provisions under the capital plan rule and subpart O of the Federal Reserve's Regulation YY (12 CFR part 252). Return to text

 7. 12 USC 5365(i)(1). Return to text

 8. See 82 Fed. Reg. 9308 (February 3, 2017). Return to text