Specialized teams inside the nation’s biggest banks are hunkered down, working out how they would handle a nightmare economic scenario the Federal Reserve dreamed up. Turns out, reality is worse.

The annual stress tests for the biggest banks, due April 6, are meant to gauge if banks would survive a hypothetical recession that sends the stock market plunging, oil into a tailspin, loan defaults rising and unemployment to society-shattering highs.

In recent years, the banks looked strong enough to manage those conditions, giving regulators comfort that the U.S. financial system is stable. In turn, the banks have been allowed to return billions of dollars to shareholders through dividends and stock buybacks.

The new coronavirus has some wondering if this year it is even worth it.

Some economists are predicting that the current downturn could be sharper and reach farther than the worst-case scenario on this year’s test, which the Fed refers to as “severely adverse."

“The severely adverse scenario looks pretty rosy right now," said Pete Gilchrist, executive vice president of Novantas Inc., a bank services company.

For instance, the Fed’s severe recession imagines U.S. gross domestic product dropping 9.9%, unemployment hitting 6.1% and the Dow Jones Industrial Average falling to 18623 by the end of June.

Last week, Goldman Sachs economists projected a 24% drop in second-quarter GDP, and Treasury Secretary Steven Mnuchinsaid unemployment could hit 20% without government intervention. The Dow closed at 18592 Monday, then rallied to 20705 Tuesday.

Bank stocks have been hit harder than the broader market as industry profits are likely to plunge and loan losses jump.

But so far, analysts, bankers and the public don’t broadly have the same worries they did during the 2008 financial crisis about whether big banks would survive. Banks have spent much of the past decade shoring up capital levels, and they have reined in some of their riskier activities after a regulatory crackdown.

As of now, the banks and Fed are operating as scheduled, even as the central bank is also rolling out extraordinary measures designed to keep markets functioning. The Fed on Tuesday said it would relax some examination work, particularly at smaller banks, but that big banks should still submit their plans.

In the stress tests, the Fed devises two scenarios: one a baseline and one that is generally a spiced-up version of 2008. It hands the banks spreadsheets detailing how the stock market, income and other metrics would collapse and then slowly recover. The banks run their models to figure out how they envision using capital, including dividends and share buybacks, and then hand the Fed reams of data it uses to run its own models. This year, how the banks perform will determine the capital level they must stay above.

The banks at this point have mostly run their models, and it is too late to insert the world’s far more alarming crisis, people familiar with the process said.

Bankers are telling the Fed the results, typically released in June, will be irrelevant given how rapidly coronavirus has slammed the brakes on the economy and the unknown impact that will have on everything from consumer spending to bank balance sheets. The big lenders already have temporarily halted buybacks after the coronavirus was declared a pandemic.

Some in the industry are questioning whether the Fed should cancel or delay the test, or hold off on capital-plan approvals, the people said.

Some bankers and advisers say that banks and regulators themselves should be focused on the real emergency at hand, not the stress tests. The Bank of England on Friday called off its stress test for this year, urging banks to focus on the crisis. Some say the results could even backfire and give false hope at a time the coronavirus crisis is still spreading.

“It’s a waste of time for both the banks and regulators," said Kamal Mustafa, chairman of Invictus Group, which works on the tests with banks. “It risks a misdirection…telling the banks that you have enough capital when no one knows."

Others say the tests have proven a stabilizing force. The results of the original tests, released in 2009, were a balm for a market still in a near panic over the financial crisis. They say the results matter less than the dialogue they spur between banks and regulators. Novantas’s Mr. Gilchrist said the process can still improve modeling and planning for stresses, and that the work takes far less time than before.

The tests also provide some transparency into the Fed. “In effect, stress tests are also a test of the Fed’s supervision of large banks," the Fed’s vice chairman for supervision, Randal K. Quarles, said in a speech last year.

Sen. Sherrod Brown, the top Democrat on the Senate Banking Committee, called for regulators to stop making new rules so they can focus on the coronavirus—but the stress tests, he says, should stay.

“Uncertain times are exactly when stress tests are most important," Sen. Brown said in a statement to The Wall Street Journal. “Right now as we deal with the economic fallout of coronavirus we need the Fed to keep close watch over the financial system."

Over the years, bankers and some economists have complained that the stress tests’ worst-case scenarios are too far-fetched. Now those in the industry are discussing what might change after this year.

One addition most expect in coming years: The Fed could start putting a global pandemic into the test.

This story has been published from a wire agency feed without modifications to the text.

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