What 2025’s Stress Tests Revealed About Capital Requirements

In the 1990s, a Japanese train engineer discovered that the kingfisher bird could dive into water with barely a splash. This observation inspired the redesign of Japan’s bullet trains to reduce tunnel boom and increase speed, simply by mimicking the bird’s beak.The lesson here for community financial institutions (CFIs) — even the most complex systems can benefit from streamlined, low-impact solutions. The Federal Reserve’s latest stress test results suggest a shift toward a less jarring approach in assessing capital strength — one that could make waves in how community financial institutions (CFIs) think about capital planning and resilience.Beneath the surface, this year’s stress test outcomes and the regulatory response offer important cues for how CFIs might approach capital planning going forward — with more flexibility, clearer signals, and smarter modeling that’s tailored to their scale.Lots of Breathing RoomReleased in June, the 2025 DFAST revealed that all 22 participating large banks would remain well capitalized under a severely adverse economic scenario. The average projected decline in common equity tier 1 (CET1) capital was just 1.8%, significantly less than the 2.8% drop forecasted in 2024. Much of this improvement stemmed from stronger pre-provision net revenue (PPNR), a reflection of better earnings in 2024, as well as less aggressive credit loss assumptions, especially in commercial and industrial loans, credit cards, and commercial real estate (CRE).

Source: 2025 Federal Reserve Stress Test Results While these outcomes are encouraging, they also highlight the stress test framework’s volatility. Changes in projected losses and income can swing widely from year to year, in part due to the “momentum effect,” where strong past performance leads to more favorable forward-looking assumptions. This makes capital buffers reactive, rather than reliably forward-looking. Recognizing this challenge, the Federal Reserve proposed in April that they would average stress test results over two years in an effort to reduce volatility in capital requirements and offer more planning predictability.Shifting to Banking StabilityIn its July announcement, the Federal Reserve reaffirmed its proposal to average stress test results over two years, aiming to reduce year-to-year volatility and bring greater transparency to the process. Vice Chair for Supervision Michelle Bowman called the move “an important next step” in improving the consistency and reliability of capital planning.While the averaging rule would apply only to large banks under DFAST, its implications reach further. The underlying shift toward clearer and more stable capital expectations matters to institutions of all sizes. For CFIs, it signals that regulators are open to recalibrating how capital buffers are set, potentially paving the way for more tailored, proportional frameworks.Smaller institutions that build credible, scenario-based capital models today may be better positioned tomorrow — whether through engagement in policy discussions or participation in future capital relief or buffer flexibility programs. Being proactive now could pay off later, as the regulatory environment becomes more adaptive to risk and scale.Practical Stress Testing Tips for CFIsWhile formal supervisory stress testing is typically reserved for the largest institutions, the insights from DFAST and regulatory guidance offer a roadmap that smaller community financial institutions can adapt to their own scale. Stress testing doesn’t have to be complex or costly to be effective. In fact, CFIs are uniquely positioned to apply these principles in more targeted, relationship-informed ways. Here are four actionable strategies CFIs can implement to improve capital resilience:

More Than a Mere Regulatory ExerciseThe 2025 DFAST results underscore that even the most sophisticated, well-capitalized banks can benefit from sharper scenario design and stable capital expectations. For CFIs, stress testing is not just a checkbox — it can and should be a practical, adaptable tool smaller institutions use to safeguard capital, improve planning, and navigate uncertainty.For CFIs with concentrated portfolios or exposure to localized economic fluctuations, stress testing offers a way to translate risk into insight. When done thoughtfully, it can reveal hidden vulnerabilities, sharpen board-level decision-making, and justify prudent changes in credit, capital, or lending strategies.Crucially, stress testing doesn’t have to be resource-intensive to be effective. From peer-based benchmark modeling to simple spreadsheet scenarios, tools are already available and scalable to your institution’s size and complexity.The key is making stress testing part of the ongoing conversation around risk, growth, and resilience. By embedding stress testing into your strategic toolkit, you can build confidence among directors, regulators, and customers alike — and better prepare for the next period of stress, whenever it comes.