Federal Reserve Financial Stress Test Primer Breakdown of the Financial Stress Test Process, What’s Measured, and the Various Scenarios Measured June 27, 2016 Producer: Hunter Hamrick Edited by: Katharine Conlon Director: Afzal Bari

FINANCIAL STRESS TEST PRIMER The Financial Stress Test Is Mandated by Dodd-Frank and Measures Banks on Three Economic Scenarios Background on the Federal Reserve Stress Test Process Sources: Federal Reserve, “Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results,” June 22, 2016; Federal Reserve, “2016 Supervisory Scenarios for Annual Stress Tests Required Under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule,” January 28, 2016; Wall Street Journal, “What Are The Fed’s Stress Tests?,” June 23, June 28, 2016 | Hunter Hamrick Any U.S. bank that has more than $50 billion in assets must conduct the financial stress test. Bank holding companies and state member banks with more than $10 billion are required to run company-run stress tests The purpose of these tests is to test the readiness of large financial institutions in the event a financial crisis occurs. Many economists note that these tests are a response to the fact that many banks were not properly prepared for the 2008 financial crisis The scenarios measure a banks ability to respond to 28 possible variables from a moderately slow growing GDP to a sharply inflated U.S. dollar The test involves measuring a bank’s ability to respond properly to three scenarios : baseline, adverse, and severely adverse The test is conducted annually and released in two separate parts. The annual financial supervisory stress tests are mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act

FINANCIAL STRESS TEST PRIMER 33 Major Banking Institutions Are Required to Take The Financial Stress Test This Year Portion of the Banks Required to Take the Stress Test Sources: Federal Reserve, “Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results,” June 22, 2016; Federal Reserve, “2016 Supervisory Scenarios for Annual Stress Tests Required Under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule,” January 28, 2016; Wall Street Journal, “What Are The Fed’s Stress Tests?,” June 23, June 28, 2016 | Hunter Hamrick

The Federal Reserve Releases The Results of the Financial Stress Test In Two Parts FINANCIAL STRESS TEST PRIMER June 28, 2016 | Hunter Hamrick Sources: Federal Reserve, “Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results,” June 22, 2016; Federal Reserve, “2016 Supervisory Scenarios for Annual Stress Tests Required Under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule,” January 28, 2016; Wall Street Journal, “What Are The Fed’s Stress Tests?,” June 23, Overview of the Two Financial Stress Tests Released Dodd-Frank Act Supervisory Stress TestingComprehensive Capital Analysis and Review The Federal Reserve uses this test to analyze the banking institution as a whole The test analyzes the banking institutions ability to handle hypothetical scenarios involving economic downturn and financial crises No “pass” or “fail” grade on this test. The test results conclude how the banking institution fairs in these hypothetical situations The Federal Reserve uses this test to analyze a banks overall plan to handle hypothetical scenarios involving economic downturn and financial crises The review evaluates a banking institutions capital adequacy, internal capital adequacy assessment processes, and their plans to make capital distributions The Federal Reserve will deem whether or not specific banks “pass” or “fail” the test Note: The Federal Reserve releases the results of the two tests one week apart.

Overall, the Federal Reserve Scenarios Involve 28 Variables FINANCIAL STRESS TEST PRIMER June 28, 2016 | Hunter Hamrick Sources: Federal Reserve, “Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results,” June 22, 2016; Federal Reserve, “2016 Supervisory Scenarios for Annual Stress Tests Required Under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule,” January 28, 2016; Wall Street Journal, “What Are The Fed’s Stress Tests?,” June 23, Category of Variables Involved in The Financial Stress Test VariableTopics Covered Economic Activity and PricesPercent changes in Real and Nominal changes in GDP, the unemployment rate, percent changes in real and nominal disposable personal income, and percent change in the consumer price index Aggregate Measures of Asset Prices or Financial Conditions Index of house prices, commercial property prices, equity prices, and the U.S. stock market volatility Interest RatesRate on the 3-month Treasury bill, the yield on the 5-year Treasury bond, the yield on the 10-year Treasury bond, the yield on a 10-year BBB corporate security, the interest rate associated with a fixed-rate 30-year mortgage, and the prime rate Country and Country blocksAnnual rate percent change in real GDP, percent change in CPI, the level of U.S. foreign currency exchange rate, changes in the Euro area, changes in the United Kingdom, changes in developing Asia, and changes in Japan

The Federal Reserve Financial Stress Test Tests Banks In Three Scenarios FINANCIAL STRESS TEST PRIMER June 28, 2016 | Hunter Hamrick Sources: Federal Reserve, “Dodd-Frank Act Stress Test 2016: Supervisory Stress Test Methodology and Results,” June 22, 2016; Federal Reserve, “2016 Supervisory Scenarios for Annual Stress Tests Required Under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule,” January 28, 2016; Wall Street Journal, “What Are The Fed’s Stress Tests?,” June 23, Overview of the Three Financial Stress Test Scenarios Type of ScenarioDetails of Scenario Baseline ScenarioOutlook of U.S. real activity, inflation, and interest rates similar to the consensus projections from Blue Chip Economic Indicators Adverse ScenarioWeakening economic activity across all countries and country blocs involved in the scenario Slight decrease in the overall U.S GDP Slight growth in unemployment and a moderate U.S. recession A period of minor deflation and dropping consumer prices in the United States, associated countries, and associated country blocs Severely Adverse ScenarioSevere global recession and decrease in the U.S GDP A period of heightened corporate financial stress and negative yields for U.S. Treasury securities Major growth in unemployment rate A period of major deflation and dropping consumer prices in the United States, associated countries, and associated country blocs