Fed includes 'heightened stress' in leveraged loans in 2020 bank stress tests

FILE PHOTO: The Federal Reserve building is pictured in Washington, DC, U.S., August 22, 2018. REUTERS/Chris Wattie/File Photo

WASHINGTON (Reuters) - Large banks with significant trading operations will have their finances tested in 2020 against a scenario that includes “heightened stress” in leveraged loans, the Federal Reserve announced on Thursday.

The Fed also plans to test banks with substantial trading or processing operations against a hypothetical counterparty default as part of its 2020 round of stress tests.

The Fed’s focus on leveraged lending in the upcoming round of stress tests comes after regulators and some in the industry have aired concern for years over the rapid growth in the corporate debt market, particularly in loans to already heavily-indebted firms.

“This year’s stress test will help us evaluate how large banks perform during a severe recession, and give us increased information on how leveraged loans and collateralized loan obligations may respond to a recession,” said Fed Vice Chairman Randal Quarles in a statement.

The annual health check of big bank finances will continue to include a hypothetical severe economic downturn, where the unemployment rate nearly triples to 10% and economies worldwide contract significantly.

Eleven of the largest U.S. banks, including Goldman Sachs and JPMorgan Chase, will have to face the leveraged lending component, and those firms will also face the specific test on counterparty default alongside custody banks Bank of New York Mellon and State Street Corporation.

All told, 34 banks with more than $100 billion in assets will face this year’s stress test. The Fed approved capital plans for all tested banks after the 2019 cycle.

Reporting by Pete Schroeder; Editing by Chris Reese, Editing by Franklin Paul