Board of Governors of the Federal Reserve System

Executive Summary

In June, the Federal Reserve released the results of its annual supervisory stress test² and the results of a sensitivity analysis, which assessed the resilience of firms under a range of plausible downside scenarios stemming from the outbreak of the coronavirus and the imposition of associated containment measures ("COVID event").³ Those results indicated that the banking sector was sufficiently capitalized and could continue lending to businesses and households during a severe recession.

However, material uncertainty was present at the time regarding the trajectory of the economic recovery and its effects on the financial health of banking organizations. As a result, the Board required the 33 firms to resubmit their capital plans and limited the capital distributions by these firms in order to preserve capital and support lending. The Board also announced that it would conduct an additional stress test in late 2020.

Net income declined in 2020 relative to 2019, but firms reduced net common capital distributions and retained more of that income (see figure 1). The decline in capital distributions is partly due to actions taken by the Board to limit capital distributions for the third and fourth quarters of 2020. Combined with firms' voluntary capital distribution reductions, these actions helped to maintain, and slightly increase, aggregate capital levels during a year in which firms also built loss absorbing capacity by more than doubling loan-loss reserves. The aggregate common equity tier 1 capital (CET1) ratio increased from 12.0 percent in the fourth quarter of 2019 to 12.2 percent in the second quarter of 2020 and to 12.7 percent by the third quarter of 2020.

The results of the December 2020 stress test show that firms maintain strong capital levels under two hypothetical severe scenarios. The scenarios feature severe global downturns with substantial stress in financial markets that serve to capture a broad set of severe but plausible risks.⁴ Projected losses under both scenarios exceed $600 billion, considerably larger than in the June 2020 stress test. However, the large reserve buildup during the first half of the year helped cushion some of the increase in losses, and all firms remain above their minimum risk-based capital requirements. Table 1 shows the starting and post-stress minimum ratios for both scenarios in aggregate (see appendix B for the full results for each firm).

Table 1. Aggregate capital ratios, actual, projected 2020:Q3–2022:Q3, and regulatory minimums

Macroeconomic and financial conditions have generally improved since June 2020. Despite these improvements, future economic conditions and the ultimate path of the current recovery remain uncertain, depending on the course of the COVID event. In light of this uncertainty, the Board is extending its limits on capital distributions into the first quarter of 2021, with certain modifications.

In particular, for all firms, the Board will

• continue to limit dividend payments based on recent income, and
• limit share repurchases based on recent income.

These restrictions will apply into the first quarter of 2021 and may be extended by the Board.

Summary of Results

The results of the December stress test suggest that, in the aggregate, the 33 firms would experience substantial losses and lower revenues under the hypothetical recessions but could continue lending to creditworthy businesses and households. This is due, in large part, to the substantial buildup of capital since the 2007–09 financial crisis (see figure 2) and more than a doubling of loan-loss reserves during the first half of 2020. In aggregate, capital ratios remain well above their required minimum levels throughout the projection horizon under both scenarios.

In the severely adverse scenario, the aggregate CET1 ratio falls from an actual value of 12.2 percent in the second quarter of 2020 to a projected minimum of 9.6 percent before rising to 10.2 percent at the end of the third quarter of 2022. In the alternative severe scenario, the aggregate CET1 ratio declines to a minimum of 9.7 percent, but rises to 9.9 percent at the end of the third quarter of 2022. The declines in capital ratios, both in the aggregate and for individual firms, do not include the effect of common stock dividend distributions.

For the December stress test, aggregate losses over the projection horizon at the 33 firms are projected to be $629 billion under the severely adverse scenario and $612 billion under the alternative severe scenario. For the June stress test, total losses under the severely adverse scenario were $550 billion for the same 33 firms.

Despite higher loan losses compared to the June stress test, projected provisions for loan losses are smaller. Provisions are projected to be $429 billion under the severely adverse scenario and $440 billion under the alternative severe scenario, while provisions were $489 billion for the June stress test. This difference reflects a significant increase in firms' loan-loss reserves since the beginning of the year. If firms had maintained the same level of loan-loss reserves as in the fourth quarter of 2019, projected provisions would be about $100 billion higher for both scenarios in this stress test.

Lower provisions are offset by lower aggregate projected pre-provision net revenue (PPNR) than in the June stress test. PPNR in the December stress test under the severely adverse scenario and alternative severe scenario is projected to be $371 billion and $363 billion, respectively. For the June stress test,
PPNR under the severely adverse scenario was $429 billion for the same 33 firms*. These decreases are partly attributable to a flatter yield curve in both scenarios, which reduces net interest margins.

Provisions for loan losses and PPNR are the main drivers of pre-tax net income. Lower projected provisions approximately offset reduced PPNR so that the projected decline in pre-tax net income is similar to that of the June stress test. The projected decline in pre-tax net income is 0.9 percent of average total assets for the severely adverse scenario and 1.1 percent for the alternative severe scenario, compared to a decline of 1.1 percent in the June stress test.

Further details of the results are provided in the "Supervisory Stress Test Results" section of this report, which are presented both in the aggregate and for individual firms.

Comparison to the Sensitivity Analysis

The results from the December stress test, while similar to those of the June stress test, are less severe than the sensitivity analysis results published earlier this year. The sensitivity analysis explored a set of alternative downside scenarios, which were designed in early April and reflected the wide range of projections at the time by professional forecasters for key macroeconomic indicators, such as the unemployment rate and gross domestic product (GDP).

In contrast, the December stress test scenarios were developed as plausible but severe, given the macroeconomic and financial conditions as of September 2020. For example, the unemployment rate in April, when the sensitivity analysis scenarios were designed, was 14.7 percent, and the sensitivity analysis added further stress to that figure; by September, the unemployment rate had declined to 7.9 percent, which was the base to which further stress was added for the December stress test.

Loan losses under the December stress test scenarios are higher compared to the June stress test scenario, but are lower than losses under the alternative downside scenarios in the sensitivity analysis, due to the higher severity of those scenarios. Aggregate projected loan losses under the alternative downside scenarios ranged from around $560 billion to just over $700 billion, compared to $514 billion and $491 billion under the severely adverse and alternative severe scenarios for the December stress test, respectively.

The minimum CET1 ratio fell to between 7.7 and 9.5 percent under the various scenarios considered in the sensitivity analysis. This range is lower than the December stress test's projected minimum ratios of 9.6 and 9.7 percent under the severely adverse and alternative severe scenarios, respectively. The difference is partly attributable to the increase in loan-loss reserves during the first half of 2020.

Overview

This report provides

• details of the supervisory severely adverse and alternative severe scenarios used in the December stress test;
• an overview of the analytical framework and methods used to generate the Federal Reserve's projected results, highlighting several changes from the June stress test;⁵
• additional details about the Federal Reserve's assumptions in this supervisory stress test; and
• the results of the supervisory stress test under the severely adverse and alternative severe scenarios for the firms that participated in the December stress test, presented both in the aggregate and for individual firms.⁶

 

References

 

 2. See Board of Governors of the Federal Reserve System, Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Results (Washington: Board of Governors, June 2020), https://www.federalreserve.gov/publications/files/2020-dfast-results-20200625.pdf. Return to text

 3. See Board of Governors of the Federal Reserve System, Assessment of Bank Capital during the Recent Coronavirus Event (Washington: Board of Governors, June 2020), https://www.federalreserve.gov/publications/files/2020-sensitivity-analysis-20200625.pdf. Return to text

 4. See the "Supervisory Scenarios" section below. Return to text

 5. See Board of Governors of the Federal Reserve System, Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Methodology (Washington: Board of Governors, March 2020), https://www.federalreserve.gov/publications/files/2020-march-supervisory-stress-test-methodology.pdf. Return to text

 6. The 33 firms that participated in the December stress test are Ally Financial Inc.; American Express Company; Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC; BMO Financial Corp.; BNP Paribas USA, Inc.; Capital One Financial Corporation; Citigroup Inc.; Citizens Financial Group, Inc.; Credit Suisse Holdings (USA), Inc.; DB USA Corporation; Discover Financial Services; Fifth Third Bancorp; The Goldman Sachs Group, Inc.; HSBC North America Holdings Inc.; Huntington Bancshares Incorporated; JPMorgan Chase & Co.; KeyCorp; M&T Bank Corporation; Morgan Stanley; MUFG Americas Holdings Corporation; Northern Trust Corporation; The PNC Financial Services Group, Inc.; RBC US Group Holdings LLC; Regions Financial Corporation; Santander Holdings USA, Inc.; State Street Corporation; TD Group US Holdings LLC; Truist Financial Corporation; U.S. Bancorp; UBS Americas Holding LLC; and Wells Fargo & Company. In addition to DB USA Corporation, DWS USA Corporation, a second U.S. intermediate holding company subsidiary of Deutsche Bank AG, was required to resubmit its capital plan. Return to text

*Note: The Federal Reserve revised this report on June 24, 2021: under the Executive Summary, the sentence "For the June stress test, PPNR under the severely adverse scenario was $430 billion for the same 33 firms." has been revised to "For the June stress test, PPNR under the severely adverse scenario was $429 billion for the same 33 firms."