WASHINGTON—The biggest banks in the U.S. have enough reserves to continue lending in a severe economic downturn, a sign that firms a decade into an economic expansion are faring better in annual “stress tests” despite increasingly dire hypothetical scenarios.
The Federal Reserve on Friday said 18 of the largest banks could weather an extreme market shock—including double-digit unemployment and a 50% U.S. stocks decline—and still have enough capital to continue operating.
The positive scorecard signals the banks—including JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Goldman Sachs Group Inc.—are likely to get a green-light to increase dividend payouts and buy back shares when the second round of test results are released next week.
“The results confirm that our financial system remains resilient,” Fed Vice Chairman Randal Quarles said in a written statement. He said the firms, representing about 70% of U.S. bank assets, “would be well-positioned to support the economy even after a severe shock.”
While banks faced one of the toughest stress-test scenarios yet, the exercise has become easier because of a recent Fed overhaul of the tests, including a reduced threat of a public rebuke for banks that fare poorly.
“The stress tests are still a meaningful constraint on capital distributions,” said Arthur Angulo, a managing director at Promontory Financial Group and a former Fed official. ”It has become less burdensome and it is certainly less of a public spectacle than it was in years past.”
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Under the Fed’s “severely adverse scenario,” the big banks would together lose $410 billion—an improvement from the $464 billion aggregate losses projected in last year’s worst-case hypothetical scenario for the same firms. Their common equity Tier 1 capital ratio, which measures high-quality capital as a percentage of assets, would fall to a low of 9.2%, from an actual level of 12.3% at the end of last year.
The tests were implemented after the 2008 financial crisis to ensure banks have enough reserves to avert government bailouts even in a severe recession. Banks have since boosted their capital buffers and they have performed increasingly well in the stress tests in recent years.
Banks said those results proved the industry was healthy and deserved a more consistent and transparent stress testing regime.
“The U.S. banking system is extremely well capitalized,” said Francisco Covas, the head of research at an industry trade group called the Bank Policy Institute, in a press release. The uncertain outcome of the stress tests “leads to excessive volatility in banks’ capital requirements over time, which hinders banks’ ability to further support economic growth,” he added.
The Fed runs two rounds of tests each year. The first determines how each bank’s portfolio would fare under the scenarios in a “quantitative,” or numbers-based review. Next Thursday it will release a second round that takes into account how much each bank wants to spend in dividends and shareholder buyouts, as well as “qualitative” factors such as the accuracy of a bank’s internal data and its board of directors.
Seventeen banks with assets generally between $100 billion and $250 billion were allowed to skip the stress tests this year as they transition into a new biennial schedule.
Under the new rules, most banks next week will no longer face the possibility of failing under the subjective portion of the test.
If they perform badly under that part of the test, banks could still be punished by the Fed through a future enforcement action or other punishment. Five U.S. units of foreign banks are still on the hook to fail in that part of the test because they are newer to the process.
Banks could still face a public rebuke under next week’s numbers-based portion of the test, which evaluates whether their capital would fall below regulatory requirements under the stress scenario. This has rarely happened because the Fed allows banks to reduce shareholder payouts and resubmit their capital plans if they are set to fail. The last firm that failed on the quantitative portion of the test was Zions Bancorp . in 2014.
The Fed also has helped banks avert a failing grade even when they didn’t manage to clear capital requirements under the doomsday scenario.
Last year, the capital levels of Goldman Sachs Group, Inc. and Morgan Stanley fell below regulatory minimums under the most severe scenario. While both weren’t allowed to increase payouts, the banks received a “conditional non-objection” grade rather than having to drastically cut payouts or fail outright.
The Fed has proposed eliminating the threat of failure entirely in the quantitative portion of the test. Under a proposal from last year, the test results would instead be integrated into a continuous capital requirements for big banks.
Write to Lalita Clozel at lalita.clozel.@wsj.com
https://www.wsj.com/articles/big-banks-ace-first-round-of-federal-reserve-s-stress-tests-11561149000
2019-06-21 20:30:00Z
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