The largest banks and financial institutions in the United States will face a new set of supervisory scenarios as part of the Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank stress test exercises to see how the banks would fare in a “severely adverse” economic situation, according to an announcement  from the Federal Reserve  on Thursday.
The purpose of the CCAR is to evaluate the largest U.S.-based bank holding companies to determine the adequacy of their capital planning processes, which include capital planning actions such as dividend payments, share buybacks, and issuances. The 2016 CCAR covers 33 bank holding companies with total consolidated assets of $50 billion or more.
The Dodd-Frank stress tests assess the firms to determine if their capital levels are sufficient to absorb losses and still lend to households and businesses during economic shocks such as the one the country suffered through in 2008, when several of the nation's largest financial institutions received multi-billion dollar bailouts from the government funded by taxpayers.
The supervisory outcomes are measured under three different scenarios: severely adverse, adverse, and baseline.
“In adjusting the scenarios for our yearly stress testing program, we strive to assess the resilience of the nation's largest banks in a variety of potential adverse environments,” Fed Governor Daniel K. Tarullo said. “It is important that the tests not to be too predictable from year to year.”
“In adjusting the scenarios for our yearly stress testing program, we strive to assess the resilience of the nation's largest banks in a variety of potential adverse environments.”
Fed Governor Daniel Tarullo
The “severely adverse” scenario includes a severe global recession that sees the unemployment rate rise from 5 to 10 percent (up 5 percentage points) and a heightened period of corporate financial stress and negative yields for short-term U.S. Treasury securities, according to the Fed. The “adverse” scenario presents a moderate recession and mild deflation in the U.S. along with weakening economic activity across all countries. The “baseline” scenario includes a profile similar to average projections from economic forecast surveys.
According to the Fed's announcement, each scenario includes 28 variables. Those variables include GDP, unemployment rate, stock market prices, and interest rates, and they encompass economic acivity both domestically and globally.
One carryover from the CCAR in previous years is that six of the bank holding companies are required to factor global market shock into their scenarios.
Bank holding companies that are participating are required to submit their capital plans and stress test results by April 5, 2016, and the results will be announced on June 30, 2016.