[WASHINGTON, DC] A group of large US banks comfortably cleared the Federal Reserve’s annual stress test, setting the stage for lenders to boost buybacks and dividends for shareholders.
The 22 banks subjected to this year’s test all remained above minimum capital levels in a hypothetical recession. The lenders would withstand more than US$550 billion in losses, with the results showing that “large banks are well-positioned to weather a severe recession”, the regulator said in a statement.
The Fed estimated that the group of banks’ common equity tier 1 capital ratio – which provides a cushion against losses – declined 1.8 percentage points, but lenders would still hold more than double the 4.5 per cent minimum requirement.
The annual exam, a product of the 2008 global financial crisis, helps determine how much profit banks can pay out in dividends and stock buybacks rather than keep to withstand potential losses. While big lenders have largely sailed through the test in recent years, the process can occasionally surprise, such as when banks scaled back capital return plans in 2022 after a tough exam.
This year, the Fed imposed a hypothetical scenario on lenders with a 10 per cent peak in unemployment, a 50 per cent drop in equity prices, and a 30 per cent decline in commercial real estate prices. Last year’s test had similar unemployment but larger drops in asset prices.
The central bank noted that the results of this year’s test led to lower loan losses in a less severe scenario, due to the mild slowing of the US economy in 2024 among other factors. The results were also impacted by lower private equity losses and higher net revenue.
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The less rigorous test means banks will probably be able to have lower capital requirements, which would allow for larger dividends and share buybacks, said Ian Katz, managing director at Capital Alpha Partners in Washington.
A Fed official said banks are expected to announce buyback plans on Tuesday (Jul 1).
Shares of Wells Fargo, Bank of America, Goldman Sachs Group and JPMorgan Chase rose after the close of regular trading in New York on Friday.
Stress test overhaul
The Fed announced last year it planned to make changes to its process and in April unveiled a proposal to average results over two years when setting capital requirements. That plan would also delay the effective date of the annual stress-capital buffer requirement from Oct 1 to Jan 1.
Additional updates to the stress test process are expected later this year, potentially including the release of the models used. Officials will also seek public input on the changes.
The Fed’s vice-chair for supervision, Michelle Bowman, said in a statement that such changes would help the agency address the “excessive volatility in the stress test results and corresponding capital requirements”.
Banking and business groups sued the Fed over the tests in December, arguing they want more transparency and input into how the rules are adopted. In May, those groups asked the US District Court for the Southern District of Ohio to put the litigation on hold until Aug 1, saying that the Fed was engaged in a “good faith effort” to address their concerns.
Chair Jerome Powell reiterated this week the Fed’s commitment to disclosing the stress test models later this year. As the Fed’s new top bank cop, Bowman has also signalled her support for increasing the transparency of the tests.
Her predecessor, Fed governor Michael Barr, has criticised the proposed changes though, saying that lenders would be able to “game the capital requirements once they know the details of the stress test”.
The changes to the stress test process come as the Fed is looking at modifying several rules, including lowering the enhanced supplementary leverage ratio, which requires banks to hold a certain amount of capital relative to their assets. The central bank unveiled plans Wednesday to ease that rule, which banks have said limits their ability to act as intermediaries in the US$29 trillion Treasuries market.
Bowman is also expected to support easing the requirements of a bank capital plan known as Basel III endgame. That proposal would have hiked the biggest banks’ capital requirements by 19 per cent, but the Fed later walked it back after industry opposition.
The Fed plans to hold a Jul 22 conference on banks’ capital requirements, which will feature discussions on the Basel III endgame, the stress testing framework, the capital surcharge for the largest lenders and leverage requirements. BLOOMBERG
