July 16, 2025Blog
2025 Fed stress test: Private credit and hedge funds are not a systemic risk
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2025 Fed stress test: Private credit and hedge funds are not a systemic risk
The Fed found the banking system to be resilient and well-capitalized in the event of a severe economic downturn.
Key findings from the Fed:
Loss rates from NBFI exposures (i.e., the percentage of loans that are uncollectible) were estimated at 7%, under a severe recession in scenario one.
The Fed concluded that NBFIs do not pose substantial credit risk to the banking system.
Hedge funds accounted for $8 billion in bank losses compared with $17 billion in losses from banks’ own trading desks in scenario two.
Global systemically important banks’ (GSIBs) total losses peaked at $33.3 billion in scenario two, but banks maintained minimum capital levels above regulatory requirements
The June 2025 Federal Reserve stress tests confirm that private credit and hedge funds do not pose a systemic risk to the financial system. The Fed found that funds could endure crippling losses or even fail without threatening the biggest and most complex banks. In addition to their system wide stress test, the Fed’s test included two new scenarios:
Scenario 1
Adverse liquidity and credit shocks to private credit and other non-bank financial intermediaries (NBFIs).
Scenario 2
The failure of five large hedge funds, accompanied by a severe economic downturn and high inflation.
The Fed found, in both cases, the banking system to be resilient and well-capitalized to absorb losses.
Scenario 1:
Banks can manage losses from NBFI exposures
The Fed found that the banking system can withstand losses from credit and liquidity shocks to private credit and other NBFIs without jeopardizing financial stability. Banks’ capital ratios remained well above the minimum requirements under the Fed scenario.
The test assumed a severe global recession that causes sharp declines in the credit quality of NBFI loan portfolios and full drawdowns on bank credit lines. The assumptions captured both credit and liquidity risks.
Even in this worst-case scenario, total bank equity capital fell by only 1.6 percentage points to a minimum of 11.8%. Total losses were projected to be about $490 billion over nine quarters. Consequently, banks’ projected loss rates – that is, the percentage of loan exposures expected to be lost due to the NBFI stress – rose to 7%.
Scenario 2:
Stress test showed limited impact from hedge funds
The Fed concluded that hedge funds do not pose a substantial risk to the banking system. Banks maintain sufficient capital to absorb losses, even under an extreme scenario involving the failure of five large hedge fund counterparties.
In this scenario, global market dislocation, spurred by higher inflation and weaker growth, triggered the hedge fund distress. As a result, the five hedge funds that are the biggest counterparties to the largest and most complex U.S. banks fail to meet margin calls, liquidate their positions, and collapse. The defaults caused “moderate” losses of $8 billion for the banks, according to the Fed.
By comparison, the affected banks lost $17 billion from their own trading activities in the same scenario – more than double the losses attributed to the hedge fund failures. The Fed noted that although the results differed across the banks, the industry overall is well positioned to withstand extreme market stress.
Meanwhile, in the scenario, Global Systemically Important Banks (GSIBs) lost $33.3 billion, driven mostly by their own trading activity ($17.2), followed by exposure to hedge fund defaults ($7.7B), and credit valuation adjustments ($8.4B). Despite the size of the shock, banks were able to absorb the losses without threatening broader financial stability.
Conclusion
The 2025 stress test underscores that private credit and hedge funds, even under extreme conditions, are not major sources of systemic risk to the banking system. Banks remain well capitalized and capable of absorbing losses from these exposures.
