New FRB 2025 Stress Testing Scenarios: Slightly Less Severe than 2024
Commentary by Thomas Delaney
The Board of Governors of the Federal Reserve System ("FRB") released the 2025 stress testing scenarios for large banks. The tests reflect slightly less severe scenarios than last year.
The FRB tests consist of two primary scenarios: a baseline scenario reflecting average economic projections and a severely adverse scenario designed to simulate a global financial crisis. The stress tests evaluate whether banks are sufficiently capitalized to absorb losses and continue lending in the event of a "hypothetical severe global recession accompanied by a period of heightened stress in commercial and residential real estate markets and in corporate debt markets."
Under the 2025 severely adverse scenario, the US unemployment rate rises from 4.1% to 10% by the third quarter of 2026. The scenario assumes significant declines in asset prices, including a 33% drop in house prices and a 30% decline in commercial real estate prices. Global markets face additional shocks, and banks with substantial trading or custodial operations must account for the default of their largest counterparty.
According to the FRB, compared to 2024, the 2025 severely adverse scenario has (i) "a slightly smaller increase in the unemployment rate in the United States," (ii) "a somewhat lower starting level of interest rates as well as a higher trough for the long-term interest rates," (iii) "slightly smaller declines in house prices ... [a] response to the slightly lower ratio of nominal house prices to per capita disposable income at the end of 2024," (iv) "a decline in commercial real estate prices that is 10 percentage points smaller," (v) a less severe decline in equity prices and increase in corporate bond spreads, and (vi) a relatively similar recession scenario for the Euro area (though "less severe in all other countries or country blocs").
The FRB emphasized that the scenarios are not "forecasts." Banks subject to the test must submit their capital plans to the FRB in accordance with regulatory deadlines.
Commentary
This year, as compared to the adverse scenarios described for 2024, the unemployment shock rate is set at 10%, the same as the 2025 scenario. There is a slight difference in the starting unemployment rate reflecting the improvement in the level of unemployment that occurred in 2024. Perhaps this demonstrates that there can be business as usual, despite the turbulence being experienced by Federal Departmental agencies, at least for independent agencies such as the Federal Reserve.