The Federal Reserve's 2013 stress test scenarios for U.S. banks, which include a slowdown in Asia's developing economies on top of severe U.S. and euro zone recessions, are still as tough as last year, according to Fitch Ratings. However, we believe banks are generally better positioned and capitalized this year to be able to cope with the shocks the stress scenarios present.
The 2013 Comprehensive Capital Analysis and Review (CCAR) requires banks to ensure they are adequately capitalized to withstand a "severely adverse" scenario, with assumptions broadly similar to last year's "supervisory stress" scenario. The tests will determine whether dividends and share repurchases can go forward. We believe the opportunity for banks to revise their distribution requests will help avoid the lengthy waiting period experienced last year.
A new aspect of the test is a much more substantial slowdown in developing Asia. We believe this will not cause significant stress losses for most U.S. banks. Still, major banks with more substantial corporate and capital markets operations could suffer. Citigroup's extensive consumer banking operations in Asia, along with its corporate and capital markets activities, make the bank more vulnerable to the slowdown assumption for the region.
The Fed wants the banks to deal with shocks globally, rather than just in the U.S. As such, the "severely adverse" scenario assumes total real GDP in the euro zone contracts by 5.75% during the recession, with only modest recovery in 2014. It has been fine-tuned from a year ago to more greatly differentiate between core and peripheral economies.
The global market shock assumptions are likely to drive the most significant stress losses at the major U.S. trading banks. Some of the market stresses are lower. For example, this year a 160-bp increase is applied to the 'BBB' corporate yield rather than the 196 bps for the 2012 CCAR. However, we still expect the applied market shocks to drive large stress losses for the major banks with substantial capital markets operations, such as Citigroup, JP Morgan Chase, Bank of America, Goldman Sachs, and Morgan Stanley.
The "severely adverse" scenario is intended to present a severe economic and market shock similar to that experienced in the second half of 2008. The stress test includes a sharp 6.1% annualized drop in U.S. GDP during the first quarter of 2013, a 21.1% collapse in home prices, and 20.9% fall in commercial real estate.
A key difference in the US recessionary assumptions is a lower peak unemployment rate at 12.1%. Last year the Fed assumed unemployment would reach 13.1%. We believe a lower peak rate is likely to reduce consumer-related chargeoffs under the test, relative to last year, even though the starting point is lower due to unemployment rates falling moderately.
As part of the CCAR, the Fed will be reviewing capital adequacy, banks' internal processes for ensuring capital adequacy, and plans for capital distributions to shareholders. The 2013 CCAR applies to 19 large U.S. bank holding companies. Results of the stress test are likely to be released next March.