The nation’s largest banks would be able to keep lending to households and businesses during a sharp economic downturn, the Federal Reserve said Thursday in releasing the results of its annual stress test.
The move, which was largely expected, will free those banks from coronavirus-related restrictions on their investor payout plans after June 30. Bank stocks rose modestly after hours.
The central bank said that all 23 banks tested “remained well above their risk-based minimum capital requirements.” And it said the curbs it placed on banks amid the pandemic would end.
“Over the past year, the Federal Reserve has run three stress tests with several different hypothetical recessions and all have confirmed that the banking system is strongly positioned to support the ongoing recovery,” Randal Quarles, the Fed’s vice chair for supervision, said in a statement.
However, under the most stringent economic scenario laid out by the Fed, which included 10.75% unemployment, those banks would lose more than $470 billion. Some $160 billion of those losses would come from commercial real estate and corporate loans.
Bank Stocks Buybacks, Dividends Coming
Banks are expected to announce their payout plans — in the form of dividends and buybacks — in the days ahead. The Fed restricted dividends and buybacks for large banks last year to shore up their finances during the toughest stretches of the coronavirus pandemic.
This year, however, analysts expect something resembling the pre-pandemic pattern of the Fed deeming the banks’ finances solid, followed by a parade of announcements from banks declaring buyback and dividend increases.
“We are past the crisis, the Fed’s temporary limits on capital return expire July 1, and banks have significant excess capital. So we expect there will be dividend hikes,” bank stocks analysts at Morgan Stanley said in a research note this week.
In March, the Fed said restrictions on banks’ buybacks and dividends would end for most companies after June 30, provided results for the central bank’s yearly checkup of the financial industry allowed it.
Banks whose capital levels were above the stress test’s requirements would be freed from those restrictions. Banks that fell short would have those restrictions in place through at least Sept. 30.
After two rounds of stress tests last year, the Fed found that the nation’s largest banks “had strong capital levels.” However, the Fed initially prohibited those banks from buying back stock. It has since limited dividends and share buybacks to an amount tied to income over the past year.
In December, results from the prior stress tests gave top banks a conditional green light to buy back shares again in the first quarter, though dividends couldn’t go up. Soon after, JPMorgan Chase (JPM) announced a $30 billion repurchase program that started in Q1. Goldman Sachs (GS) also resumed buybacks.
This Year’s Bank Stress Test Scenario
The Fed’s annual stress tests, put in place after the 2008 financial crisis, gauge the potential health of the banking system in a severe economic downturn. Every year, the Fed lays out hypothetical economic scenarios. The banks, in response, try to gauge how they would fare. The Fed then decides whether the banks would fare sufficiently.
For this year’s exam, the Fed in February said that in its harshest scenario, the unemployment rate would rise by four percentage points, hitting a high of 10.75% in the third quarter of 2022. Gross domestic product would shrink 4% from the fourth quarter of last year through the third quarter of next year.
The results for the 23 large banks that participated in the annual financial checkup this year followed the economy’s sharp contraction and recovery over the past year. Banks last year initially set aside billions in reserves, amid concerns over potential consumer defaults on loans.
Since then, more people in the U.S. have received coronavirus vaccines, although the rate of vaccination has slowed. The economy is reopening. The Fed has kept interest rates near zero, established emergency lending programs and bought up billions in government bonds and mortgage-backed securities.
The Federal Reserve recently signaled more support for two interest-rate hikes in 2023, amid higher inflation.
Wells Fargo (WFC) rose 1.3% to 45.75. That stock is in a flat base with a 48.23 buy point.
Morgan Stanley (MS) rose 0.5%. Goldman Sachs moved .07% higher.
Thursday’s stress test results arrived after bank stocks moved higher after reporting first-quarter earnings.
JPMorgan CEO Jamie Dimon, in April, said stimulus benefits, possible infrastructure spending, support from the Federal Reserve and “euphoria around the potential end of the pandemic” could bring years of economic growth.
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