We take a look at the recently released Federal Reserve Board 2024 bank stress test scenarios, with an eye towards just how sensitive the stress tests are to disruptions and uncertainties created by exponential technologies – and how some disruptive markets see instability in the traditional banking system as a net positive for the strategic emergence of an alternative global currency fiat (and net positive for their alternative portfolio assets short term).
Background
In an OODA Network discussion of the Silicon Valley Bank (SVB) failure back in March of 2023 – The OODA Network on the Silicon Valley Bank Failure and the Road Ahead – we unearthed a pattern of “at work dark forces” – that accidentally or consciously caused the run on SVB: “Peter Thiel and VC chat groups are a new variable – that does not map to the 2008 crisis. They communicated through social media to accidentally or consciously cause the run on SVB. Some communications were backchannel, some were in public…the biggest risk to the financial system is VC chat groups…$42 billion exited that bank in 10 hours” based on their private chat group conversations – all behind the scenes of the publicly available information during the SVB failure crisis.
Many voices in the crypto market also applauded the failure of another traditional bank – seeing it as validation for the future of the crypto marketplace. And the markets validated their sentiment, as Jennifer Murphy, CEO of Runa Digital Assets notes: “When Silicon Valley Bank collapsed on March 10, 2023, fears of contagion sent stocks down by over -1% the next trading day, but bitcoin rose by 20%.”
In the current climate, a new development is that their are holistic, systemic interests that are hedging against the health and long term primacy of the traditional banking system. With the release of of the Federal Reserve scenarios for their 2024 bank ‘stress tests’, are these externalities, by default, black swans and/or grey rhinos that The Fed simply does not think to include even in its worst case scenarios and “exploratory analysis”? Are there force functions at work – not in the shadows, but transparent – exacerbating the stressors on the traditional banking system?
US Federal Reserve releases scenarios for 2024 bank ‘stress tests’
The U.S. Federal Reserve on Thursday released scenarios for its annual bank health checks that will assess how well 32 large lenders would fare under a severe economic shock, including a U.S. jobless rate of 10% and a collapse of real estate prices. This year’s tests will attract heightened scrutiny from investors, analysts and regulators following the failure of three banks last year, and as big banks are fighting the Fed over proposed new capital hikes that they say are excessive.
“This year’s test will also for the first time include an additional “exploratory analysis” of the banking system, which will test lenders’ resilience to a wider range of risks than the traditional tests.”
The 2024 Stress Test Scenarios
In the 2024 stress test scenario:
- The U.S. unemployment rate rises nearly 6-1/2 percentage points, to a peak of 10 percent.
- The increase in the unemployment rate is accompanied by severe market volatility, a widening of corporate bond spreads, and a collapse in asset prices, including a 36 percent decline in house prices and a 40 percent decline in commercial real estate prices; and
- Large banks with substantial trading or custodial operations are also required to incorporate a counterparty default scenario component to estimate and report potential losses and capital effects associated with the unexpected default of the firm’s largest counterparty.
- In addition, banks with large trading operations will be tested against a global market shock component that primarily stresses their trading and related positions. The global market shock component is a set of hypothetical stresses to a large set of risk factors reflecting market distress and heightened uncertainty.
For the complete 2024 Stress Test Scenarios, go to this link.
This year’s exploratory analysis includes four separate hypothetical elements that will assess the resilience of the banking system to a wider range of risks:
- Two of the hypothetical elements include funding stresses that cause a rapid repricing of a large proportion of deposits at large banks. Each element has a different set of interest rate and economic conditions, including a moderate recession with increasing inflation and rising interest rates, and a severe global recession with high and persistent inflation and rising interest rates.
- The other two elements of the exploratory analysis include two sets of market shocks that will be applied only to the largest and most complex banks. These shocks hypothesize the failure of five large hedge funds, with each under a different set of financial market conditions. Those conditions include expectations of reduced global economic activity with a negative outlook for long-term inflation, and expectations of severe recessions in the United States and other countries.
Exploratory Analysis of Risks to the Banking System
As a companion to the 2024 supervisory stress test, the Federal Reserve is conducting an exploratory analysis The analysis is distinct from the stress test and will complement it by providing aggregate banking system results against different economic and financial conditions. Taken together, the stress test and exploratory analysis will provide insight into the resiliency of the U.S. banking system. The conditions for the exploratory analysis are not Federal Reserve forecasts. The exploratory analysis will not impact large bank capital requirements. This document summarizes four elements of exploratory analysis:
- Funding stress that causes a rapid repricing of a large proportion of deposits at large banks, under a moderate global recession, combined with increasing inflationary pressures and rising
interest rates; - The same funding stress under a severe global recession combined with high and persistent
inflation and rising interest rates; - A market shock featuring a sudden dislocation to financial markets stemming from expectations of reduced global economic activity; and
- A market shock featuring a sudden dislocation to financial markets stemming from expectations of severe recessions in the United States and other countries.
What Next?
What Role Exponential Technologies and the Polycrisis (the climate crisis, regional geopolitical proxy wars, etc)?
The Fed has not chosen to include an edge case which takes in the unprecedented global polycrisis. The question we are exploring here, from the perspective of the usual OODA Loop themes and research topics, is how could any of the global crises induce any of the “four elements of exploratory analysis” itemized above? Or does the Fed need to include another standalone stress takes which tries to expand into the larger geopolitical and technological uncertainties at work globally?
Counterfactual Forces in the Marketplace – or “How Bitcoin Benefits From Global Stresses”
“….systemic stressors like bank failures and cyber attacks help an “anti-fragile” asset like bitcoin.”
And this topic is always of interest to us here at OODA Loop: is it a historically unprecedented phenomenon in this market that their exists a substantial ecosystem of financial vehicles that are a hedge bet against the U.S. led global currency system and the traditional banking system?
Jennifer Murphy, CEO of Runa Digital Assets, in a recent contribution to the CoinDesk Newsletter Crypto Long & Short, captures the thinking at work:
“Deficits – Inflation – War – Bank Failures – Cyber Attacks – De-dollarization
These risks loom large as they threaten stock and bond returns for investors. Historically, U.S. Treasuries have been a “safe haven,” providing some protection from crises, but from 2021 – 2023, Treasuries delivered -10%, their worst 3-year performance since at least the 1980s. Similarly, the 60/40 diversified portfolio suffered its worst performance period in 14 years with a return of -16% in 2022. In an increasingly uncertain world, what’s an investor to do?
In his book “Anti-Fragile,” Nassim Taleb explores the unique characteristics of things that gain from disorder. The immune system, for example, is more effective after exposure to a cold. Laws are clarified by suits and appeals. Software is “battle hardened” by hackers who exploit flaws. What if you could add a portfolio asset that may benefit from global stresses? That is improved by uncertainty and volatility?
Consider bitcoin. The Bitcoin network appears to thrive on stress. When the Chinese government banned bitcoin mining in 2021, ~50% of bitcoin mining capacity was forced to shut down or move. Within seven months, capacity had completely recovered, and it is now over 2x what it was prior to the Chinese shutdown. In the past 15 months, the world’s second largest crypto exchange declared bankruptcy, and the largest exchange was sanctioned by the U.S. Department of Justice. Bitcoin network transactions were unaffected, and trading volumes are near all time highs.
As an asset, Bitcoin may be increasingly anti-fragile as well. When Silicon Valley Bank collapsed on March 10, 2023, fears of contagion sent stocks down by over -1% the next trading day, but bitcoin rose by 20%. This “safe haven” price response was a new phenomenon for bitcoin, and time will tell if it persists. But bitcoin is outperforming all other asset classes over the last 1, 3, 5, and 10 years, periods that include many stresses.
Research from Galaxy shows that a 1% allocation to bitcoin in a 55% S&P 500 / 35% Bloomberg U.S. Agg / 10% Bloomberg Commodity portfolio over 5 years from August 2018 – August 2023 would have resulted in higher returns and better risk adjusted returns, with virtually no impact on volatility or max drawdown:Last week, Fidelity added bitcoin to its diversified ETF portfolios in Canada, with a 1% allocation for the Conservative ETF and a 3% allocation for the Growth ETF. With many bitcoin ETFs now available in the US, such as the low cost Franklin Templeton EZBC or iShares IBIT, it is easy for US investors to follow suit.
Little by little, your portfolio may gain a lot.”
Additional OODA Loop Resources
OODAcon Global Risk Briefing for 2024: Jen Hoar spoke with Johnny Sawyer about the strategic prism business leaders need to apply to the geopolitical risk environment. Following are the insights from the discussion.Note: This conversation was held on October 25, 2023 and is consistent with the concepts discussed below, specifically that “the prism on the statements made below has shifted dramatically” based on how events have unfolded since late October. With that, the overall strategic advice re: business communications techniques – and mitigating risk vis a vis geopolitical events – remain prescient, vital and strategically “evergreen.”
Geopolitical Futures: The Americas, The Northern Frontier of Mexico, The Arctic, and Africa: In this era of global polycrisis, leaders are also reacting to the major macro economic trend of the last thirty years – the fundamental driver of the tetonic shifts in geopolitics and deep inside the economies of nation-states – which is that the BRICs global share of GDP May Overtake the G7 by 2028. Further geopolitical players and regions of the global polycrisis summarized here include: The Americas, The Northern Frontier of Mexico, The Arctic, and Africa .
The Global Polycrisis: The Middle East, China, The Indo-Pacific, Russia, Ukraine, and NATO: Polycrisis: A cluster of interdependent global risks create a compounding effect, such that their overall impact exceeds the sum of their individual parts. The geopolitical players and regions of the global polycrisis (jagged transitiosn, strategies, binaries fractures, major developments, and crucial events) summarized here include: The Middle East, China and the Indo-Pacific, and Russia, Ukraine, and NATO.
Globalization Transformed and the Global Chip IT Supply Chain Disruption: Major developments, and crucial events are compiled here as globalization is transformed and The Global Chip IT Supply Chain Disruption continues astride as functions of the Global Polycrisis.
Cyber War: Power, Prestige, International Governance, and Strategy in the Age of Global Polycrisis: Competing cyber capabilities (on a spectrum from nation-state to non-state actors alike) and cyber-based conflict will continue to restructructure, reformulate, discombobulate, and transform the very essence of what power, prestige, international governance, and geopolitical strategy are in the 21st century. Fueled by the Global Polycrisis, Cyberwars will continue to take center stage.
Geopolitical Trends
Great power competition introduces new corporate risks, from supply chain disruptions to cyber threats. This competition extends to resources like food, water, and rare-earth elements, with heightened risks surrounding global computer chip supply.
Russian Invasion of Ukraine: Russia’s aggression against Ukraine prompts global repercussions on supply chains and cybersecurity. This act highlights potential threats from nations like China and could shift defense postures, especially in countries like Japan. See: Russia Threat Brief
Economic Weakness in China: China’s economy faces dim prospects exacerbated by disasters, COVID-19, and geopolitical tensions. Amid limited financial transparency, some indicators suggest China’s economic growth is severely stunted, impacting global economic stability. See: China Threat Brief
Networked Extremism: The digital era enables extremists worldwide to collaborate, share strategies, and self-radicalize. Meanwhile, advanced technologies empower criminals, making corruption and crime interwoven challenges for global societies. See: Converging Insurgency, Crime and Corruption
Food Security and Inflation: Food security is emerging as a major geopolitical concern, with droughts and geopolitical tensions exacerbating the issue. Inflation, directly linked to food security, is spurring political unrest in several countries. See: Food Security
Demographic Time Bomb: Industrialized nations face demographic challenges, with a growing elderly population outnumbering the working-age demographic. Countries like Japan and China are at the forefront, feeling the economic and social ramifications of an aging society. See: Global Risks and Geopolitical Sensemaking
