U.S. Fed incorporates COVID-19 scenarios into stress tests for banks: official

The U.S. Federal Reserve is incorporating three different recovery scenarios related to COVID-19 into this year's stress tests for large banks amid "unprecedented uncertainty" about the virus and the economy, a senior Fed official said Friday.

"The larger issue is the unprecedented uncertainty about the course of the COVID event and the economy. The range of plausible forecasts is high and continues to shift," Fed Vice Chair for Supervision Randal Quarles said in a speech about how the pandemic would affect the central bank's periodic stress tests since the 2008 financial crisis.

"Although our stress tests were not designed to test specifically against the effects of the COVID event on the economy and on our banks, they were designed to be flexible," he said, adding that the Fed will use a "sensitivity analysis" this year to assess the banks' capital requirements as part of its stress tests.

"Given the special circumstances this year we will use the results of our sensitivity analysis to inform our overall stance on capital distributions and in ongoing bank supervision," Quarles said, noting the sensitivity analysis will help the Fed judge whether banks would have enough capital if economic and financial conditions were to worsen.

According to the Fed official, the sensitivity analysis will consider three different recovery scenarios: a V-shaped recovery that regains much of the output and employment lost by the end of this year, a U-shaped recovery in which only a small share of lost output and employment is regained in 2020, and a W-shaped double dip recession with a short-lived recovery followed by a severe drop in activity later this year.

"Let me emphasize that these are not forecasts by the Fed or me, only plausible scenarios that span the range of where many private forecasters think the economy could be headed," Quarles said, adding the central bank will publish the results of stress tests next Thursday.

"We will also provide results aggregated across banks that will compare how the banking system as a whole would fare under the three distinct views of the future," he said.

Since 2009, the Fed has used the annual stress tests to measure large U.S. banks' ability to respond to severe economic and market turbulence. If a bank's capital is found to be inadequate, the central bank can block it from buying bank shares or paying dividends.