Fed Tests Big Banks for Recession Readiness. How Did They Do?

All 18 of the nation’s largest and most complex banks are strong enough to withstand a severe economic downturn and would be able to stay in business without collapsing, the Federal Reserve said Friday.

The results are from the first round of the central bank’s annual stress tests, which showed the 18 big banks have benefited from an improving economy and have balance sheets strong enough to withstand a deep global downturn and the U.S. unemployment rate rising to double digits.

The Fed adjusts its stress tests each year, depending on the economic climate. In this year’s most dire scenario, known as the severely adverse scenario, the Federal Reserve tested for a hypothetical deep global recession, with the U.S. unemployment rate jumping to 10% from its current level of 4% and the stock market falling 50% from its peak.

The Fed also tested how well the nation’s largest banks would handle a sharp drop in commercial real estate prices, as well as heightened stress in the corporate debt markets. Several economists and bank executives have cited the substantial increase in loans made to distressed companies, known as leveraged lending, as an area of concern for the financial system.

Capital One, which has a large commercial banking business, was the most negatively impacted by the Fed’s scenario but still remained more than well capitalized under the Fed’s qualifications. In a sign of how much better banks are protected compared to a decade ago, all 18 banks would have more capital on their balance sheets under the Fed’s dire scenario than they had before the 2008 financial crisis.

It was the eighth annual check-up for the banks, mandated by Congress after the financial crisis that triggered the Great Recession. The Federal Reserve tested a smaller number of banks this year, instead of the 35 that were tested in previous years. Congress passed a law in 2018 that rolled back some of the regulations put into place under the Dodd-Frank Act, one of them being the need to stress test every bank over a certain threshold of assets.

The Fed next week will release the second part of its tests, which are more closely watched. The Fed will determine whether individual establishments will be allowed to boost their dividends and buy back shares.