The newest annual “stress test” for U.S. banks will focus more sharply than ever on commercial real estate. That’s the consensus of multiple news reports following the Federal Reserve’s Feb. 3 release of criteria for the 2017 test.
As you’ll recall, these stress tests started following the 2008 financial crisis, and are meant to ensure that banks have enough capital to survive economic calamity.
According to Reuters, the 2017 exam “imagines a sudden shock in which the U.S. unemployment rate rapidly soars to 10 percent, with stocks plunging and major global economies facing sharp declines in output.” Not only is the hypothetical downturn more severe than 2016’s stress test, it also includes a larger decline in commercial real estate prices, the Fed said.
Reuters notes that “low interest rates have already pushed banks towards long-term investments like multifamily housing and commercial real estate that can deliver higher yields” and “bank regulators have become increasingly concerned about the industry’s exposure to those loans, and worry that banks have loosened underwriting standards too much.”
Interestingly, as the article points out, the most heavily concentrated commercial real estate exposure lies with community and regional banks that are not subject to the stress test.
Lenders have until April 5 to submit their results, and those who don’t prove they can weather the hypothetical downturn could have payouts to investors frozen or business investment plans halted.
Of course, all of this could be moot. As Reuters points out, “the scenarios outlined in the test came on the same day President Donald Trump is expected to issue an executive order to review banking law introduced in the wake of the 2008 crisis that required the stress test and other tough financial regulations.” The president did, in fact, do just that.