The top U.S. banks all passed the Federal Reserve’s annual stress test, which is closely watched by the financial industry, which brought much relief to investors.
The 23 financial institutions subject to the Fed’s annual bank stress test were expected to pass with little issue.
The assessment was a major hurdle towards paying billions of dollars to bank stockholders, but there is little cause for celebration due to the mixed economic picture.
Shares of JPMorgan Chase, Morgan Stanley, Goldman Sachs Group, and Wells Fargo all rose on June 28 after the results were released.
These banks were most likely to see their key capital requirements eased in light of the results, wrote analysts at Jefferies Financial Group, as their balance sheets showed improved resiliency this year.
Economic Uncertainty Plagues Bank Industry
Economic uncertainty, combined with a bank crisis that saw the collapse of three regional lenders this spring, means that the sector is less likely to take financial risks, leading to lower capital return for bank investors in the long term.Although the number of deals fell, bank investors saw great rewards in 2022 after their net interest income rose in tandem with higher interest rates and new loans due to the Fed’s aggressive money-tightening policies.
The test results determine how much liquidity banks need to set aside for the aggregate common equity risk-based capital ratio, which provides a cushion against losses.
This will potentially clear the way for investor dividends and stock buybacks as requirements are met.
The latest annual test showed that American financial institutions are able to withstand a severe global recession and turmoil in the real estate markets, said the central bank.
Despite the positive news, several banks have warned that they would likely delay announcing any potential payouts until they get more clarity on the Fed’s latest economic and regulatory conditions.
Top bank executives, like JPMorgan CEO Jamie Dimon, have argued that increasing the financial cushion would hurt lending.
Currently, the Fed’s findings back claims that the industry remains generally strong and well-funded.
Analysts at J.P. Morgan Securities also expect that dividends will increase by an average of 4 percent for the large bank market, while other lenders may skip buybacks altogether as they await regulatory updates from the Fed.
Payout ratios, which consist of dividends and buybacks, are expected to increase by 13 percent to 72 percent year-over-year at the largest banks, according to analysts at Keefe, Bruyette & Woods.
The surge in payout ratios is due to lower expected earnings rather than a sharp increase in dividends and buybacks, said the analysts.
The central bank also announced that lenders could start disclosing their plans for dividends and buybacks on June 30, but analysts expect restraint.
The Fed Raises the Stress on Banks for Annual Tests
The hypothetical scenario for this year’s annual stress test saw the U.S. unemployment rate surge to 10 percent, commercial real estate prices plunge by 40 percent, total credit card losses rise to $120 billion, and the dollar jump against most major currencies.Projected total losses for the 23 banks were $541 billion, including $100 billion in losses from commercial real estate and residential mortgages, which is in line with estimates in previous years.
The cushion against losses in a crisis was projected to decline by 2.3 percent points to a minimum of 10.1 percent due to stress, said the Fed.
The blow to real estate prices cost banks a $64.9 billion loss in loans in the stress test scenario.
After commercial real estate took a big hit when the trend toward remote work since the pandemic caused office occupancy levels to crash nationwide, the Fed has been attempting to understand the industry’s effect on credit risk in the lending sector.
“The test’s focus on commercial real estate shows that while large banks would experience heavy losses in the hypothetical scenario, they would still be able to continue lending,” the Fed said in a statement.
New Central Bank Watchdog Raises Requirements in Wake of 2023 Bank Crisis
The Fed concluded that the exercise proved that “the largest banks’ trading books were resilient to the rising rate environment tested” after the collapse of Silicon Valley Bank, which was partially blamed for a rapid rise in borrowing costs.The improved test saw America’s eight largest banks face an “exploratory market shock” for the first time, combined with massive inflationary pressures and rising interest rates.
“Today’s results confirm that the banking system remains strong and resilient,” said Fed Vice Chairman for Supervision Michael Barr in a statement.
“At the same time, this stress test is only one way to measure that strength.”
“We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.” he continued.
After being appointed to the position of the Fed’s top watchdog last year, Barr said that the central bank was considering improvements in how it assesses other types of financial stress as it reviewed its stance on lenders’ capital requirements.
He has said that the changes will seek to address issues raised by the recent bank failures.
The new market shock results will not be used in capital requirements but will be used to help regulators understand trading risks and to prepare banks for multiple scenarios in future tests.
Fed Chairman Jerome Powell said earlier this month that the biggest banks could face about a 20 percent increase in the amount of capital required to be set aside under the new Basel III requirements.
Meanwhile, the Fed is considering whether to force smaller banks with at least $100 billion in assets to also adhere to the same requirements as the bigger lenders with more than $250 billion in assets after they were ignored in this year’s stress tests.
