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The biggest US banks have all passed the Federal Reserve’s annual tests of whether they can withstand a future economic and market crisis, opening the door for them to raise dividends and share buybacks.
The Fed said on Friday that under its “severely adverse” scenario, in which unemployment surges to 10 per cent, the 22 banks, including JPMorgan Chase, Goldman Sachs and Bank of America, would lose more than $500bn.
However, they would suffer a much smaller hit to capital than in recent years and remain well within required regulatory standards.
The theoretical recession used by the Fed to test banks’ resilience was less severe than the previous year’s, underlining how regulators have adopted a more bank-friendly approach since Donald Trump won last year’s presidential election.
“Large banks remain well capitalised and resilient to a range of severe outcomes,” said Michelle Bowman, the Fed’s vice-chair for supervision.
The results of the Fed’s so-called “stress tests” will be used to calculate the minimum level of capital that banks need relative to their risk-adjusted assets, providing a key buffer to absorb losses.
Banks are optimistic that the tests will become even more accommodating after the Fed responded to a legal challenge by the main banking lobby group with a promise to overhaul the exercise. The central bank said earlier this year it planned to make the exercise more transparent and to average the test results over the past two years to reduce volatility.
The banks are required to wait until Tuesday to provide an update on what they expect their new capital requirement to be. They frequently lay out plans for dividends and share buybacks after the Fed stress tests.
The Fed said this year’s stress tests would push banks’ aggregate tier one capital ratio, their main cushion against losses, down by 1.8 percentage points — a smaller drop than in recent years and well below the 2.8 percentage point fall in last year’s exercise.
But the Fed said it expected to calculate banks’ capital requirements on the basis of its two-year averaging proposal, providing that is finalised in the coming weeks. This will increase the capital hit to 2.3 per cent. Bowman said the change was preferable “to address the excessive volatility in the stress test results and corresponding capital requirements”.
The lender with the biggest fall in its capital due to the theoretical stress was Deutsche Bank’s US operation, which had a hypothetical decline of more than 12 per cent, based on the averaged results of the last two tests. The next largest falls were at the US subsidiaries of Switzerland’s UBS and Canada’s RBC.
In this year’s “severely adverse” scenario, US GDP declined 7.8 per cent in a year, unemployment rose 5.9 percentage points to 10 per cent and inflation slowed to 1.3 per cent. House prices fell 33 per cent and commercial property prices dropped 30 per cent.
While this would be one of the most extreme recessions in history, it is milder than the one drawn up by the Fed last year. The theoretical market crash — with share prices falling 50 per cent and high-yield bonds selling off sharply — was also less severe than in last year’s exercise.
The Fed said banks benefited from their higher profitability. It added that it had included lower hypothetical losses from private equity after “adjusting how these exposures are measured to better align with these exposures’ characteristics”.
Under pressure from Trump to ease the regulatory burden in support of growth and investment, the Fed has announced plans to rework many of its rules for banks.
This week, the Fed and the two other main banking watchdogs announced plans to slash the enhanced supplementary leverage ratio, which sets how much capital the biggest banks need to have against their total assets.
