Leveraged Loans At The Center Of This Year’s Stress Test For US Banks: Federal Reserve

• The Federal Reserve has included a special factor to measure the impact of leveraged loans if an economic recession hits.
• The move has been made due to increasing concerns that the corporate sector has become increasingly geared, as loans have been provided at a staggering rate to companies including those that are already highly geared.
• 11 out of 34 banks would have the leveraged debt component as part of their stress test this year.

According to an announcement made by the Federal Reserve, large banks in the US that maintain a sizable trading operation in the country would be tested this year with a ‘heightened stress’ factor as far as leveraged loans are concerned.

The announcement also highlighted that the Federal Reserve would also include a hypothetical counterparty as a default in the stress tests it will conduct this year for banks that conduct sizeable trading operations in the country.

A primary reason why leveraged debt has come under greater focus in the upcoming rounds of stress testing by the Federal Reserve is a growing concern that the credit industry has significantly increased its lending to the corporate sector, including highly-geared firms that pose a greater risk.

According to Randal Quarles, who is the Vice-Chairman of the Federal Reserve, the 2020 stress test would offer better clarity into the resilience of large banks in times of a recession, including the impact of leveraged and collateralized loans.

Other indicators that are measured in this yearly stress test will carry forward from the previous years, including a hypothetical scenario whereby the economy undergoes a major downturn, unemployment rate rises to a whopping 10%, and global economies exhibit a significant contraction.

A total of 11 large banks in the US will be facing the leveraged lending portion in their stress test this year. These banks include big names like Goldman Sachs. Other stress test factors will also be included to develop an overall evaluation. In total, a stress test would be conducted for 34 banks in the country, selected because their assets exceed the cut-off value of $100 billion.