Fed stress test passes across the board, but with a milder bar: 22 big banks can keep paying dividends and buybacks

The Federal Reserve said major banks all passed its annual stress test, but this year’s test was clearly less severe than in prior years. The Fed said the 22 banks tested this year would still remain solvent and above the minimum threshold to keep operating after absorbing about $550 billion in hypothetical losses.

In the Fed's scenario, several key assumptions were milder than in the 2024 test: unemployment rose less, the economic contraction was less severe, commercial real estate prices fell by less, and home prices also dropped by less. As a result, the simulated shock was less painful, meaning less damage to bank balance sheets and lower potential default risk. Because banks had already passed the 2024 stress test, the market expected them to pass again in 2025.

Michelle Bowman, the Fed's vice chair for supervision, said in a statement: “Large banks remain well capitalized and can withstand a range of severe scenarios.” Bowman, a Trump appointee, became vice chair for supervision earlier this month.

It is not clear why the Fed chose a milder test this year. In a statement, the Fed said past stress tests had shown “unexpected volatility,” and it plans to seek public and industry input in future years to adjust the test. The Fed also decided to reduce the test's severity for private equity assets, saying they are typically held for long periods and are usually not sold under forced conditions during market stress.

In addition, this year's test did not cover any bank exposures to private credit. Private credit has grown to roughly $2 trillion, and Fed researchers have noted its pace of growth is alarming. The Boston Fed recently said private credit could pose a systemic risk to financial stability in a severe adverse scenario, which is exactly what stress tests are meant to examine.

There was no mention in the Fed's press release, report, or methodology of testing or measuring exposures to private credit or private debt this year.

The Fed's stress tests were created after the 2008 financial crisis to assess whether too-big-to-fail banks can withstand a similar shock. The test is essentially an academic exercise: the Fed simulates a global economic scenario and measures how it would affect bank balance sheets.

The 22 banks tested this year include the biggest institutions, such as JPMorgan Chase, Citigroup, Bank of America, Morgan Stanley, and Goldman Sachs, with assets measured in the hundreds of billions and businesses spanning the U.S. and the global economy.

Under this year's scenario, a severe global recession would push commercial real estate prices down 30% and home prices down 33%. Unemployment would rise to 10%, and stock prices would fall 50%. By comparison, the 2024 scenario assumed a 40% drop in commercial real estate, a 55% drop in stocks, and a 36% drop in home prices.

After passing the test, these large banks will be allowed to pay dividends to shareholders and buy back stock to return cash to investors. The related dividend plans will be announced next week.