Fed finalizes bank stress test overhaul

Key facts

• The Federal Reserve finalized changes to its annual stress test for large banks.
• The revamped exams aim to make the tests more transparent and less volatile.
• Public feedback will be sought on changes to test models and hypothetical economic downturns.
• Banks' stress capital buffer will be an average of the last two results to reduce volatility.
• The changes are expected to reduce year-over-year volatility in capital requirements by 50%.
• The 2026 stress test scenario projects a peak unemployment rate of 10%.

The U.S. Federal Reserve announced on Wednesday that it has finalized changes to its annual stress test for large banks, aiming to enhance transparency and reduce volatility in the exams. These revamped tests largely reflect proposals made a year prior, addressing long-standing industry complaints about the opacity and subjectivity of the tests, which determine the capital large lenders must hold against potential losses.

Under the new framework, the Fed will solicit public feedback on significant alterations to the test models and the hypothetical economic downturns used to identify bank weaknesses. Additionally, the "stress capital buffer," a capital layer determined by a bank's performance on the test, will be calculated as an average of its last two results, making the requirement less volatile. The Fed anticipates these changes will reduce year-over-year volatility in capital requirements by approximately 50% without substantially impacting overall bank capital levels.

The Federal Reserve Board also finalized the hypothetical scenarios for its annual stress test, designed to ensure large banks can maintain lending through a severe recession. The final scenarios are similar to those proposed in October. The Board has decided to maintain current stress capital buffer requirements until 2027, allowing time to incorporate public feedback into new calculations. Vice Chair for Supervision Michelle W. Bowman noted that this approach will allow for corrections to supervisory models based on public input, improving transparency, effectiveness, and fairness.

The 2026 stress test scenario projects a significant economic downturn, including a nearly 5.5 percentage point increase in the U.S. unemployment rate to a peak of 10 percent. This will be accompanied by substantial market volatility, wider corporate bond spreads, and a collapse in asset prices, with an estimated 30% drop in house prices and a 39% decline in commercial real estate prices. Banks with significant trading or custodial operations will also face a counterparty default scenario, while those with large trading operations will be tested against a global market shock component.