This year’s stress test scenarios conjure up a ghostly counterparty as a possible stand-in for Switzerland’s erstwhile major bank. 

It is a rare big bank technocrat who lives for the release of the hypothetical scenarios in the Federal Reserve’s annual stress test.

But they are out there, and the overnight publication of the details of hypothetical financial oblivion has likely kicked a loose and creaky collection of internal spreadsheets and models into action. 

Severe but Expected

This year brings much of the expected. A severe global recession with heightened stress in the US commercial and residential real estate markets.

A rising domestic unemployment rate peaking at a 1980s-like, almost unimaginable 10 percent, bringing severe market volatility with it, resulting in the inevitable chasm of widening bond spreads.

A Small Surprise

But there is an additional detail that could prompt the heart of the internal banking geek to cry out in glee at the variable-setting creativity he or she has been given.

Large banks that have significant trading or custodial businesses need to incorporate a counterparty default scenario as well.

Acute Shock

That means that they will have to estimate the potential losses from an «unexpected default» of their largest counterparty during an «acute» market shock.

But it can’t be a sovereign, a qualified central counterparty, a multilateral development bank, or supranational entities such as the BIS, the ECB, and the IMF.

Archegos Too?

That leaves us with little more than the big unspoken bugbear of private sector-based collapse akin to a failing major bank such as Credit Suisse.

But it doesn’t end there. The largest and most complex banks will also have to factor in the failure of five large hedge funds. Once again, the first thought here that comes to mind is that of an Archegos – also a key instigator in Credit Suisse’s eventual demise.

No UBS Rerun

On the positive side of things, UBS doesn’t make the list of the Fed’s largest and most complex banks, and it won’t be subject to the global market shock and counterparty default tests in 2025.

Last year, at this point, we wrote that little had changed from the Fed's 2023 stress tests, except that Credit Suisse bore the brunt of them, while UBS did not.

Clear Progress

We also wrote that UBS’s progress in cutting the risk out of Credit Suisse businesses would potentially be measurable this year and a key sign of success would be whether the bank can get rid of one - or both - the offending «Xs» plonked in the middle of the two columns on the Fed’s stress test table. 

That Xs are now gone, which means that the bank will be spared from having to theoretically relive its very recent, and very real, past.