Fed Stress Test Finds Big Banks Can Weather Severe Recession

The Federal Reserve gave the biggest U.S. banks a clean bill of health in its annual stress test, saying they would be able to continue lending to households and businesses even in severe recession.

This year’s stress test measured the 34 biggest banks’ ability to maintain strong capital levels in a hypothetical recession marked by sharply higher unemployment and a steep decline in stock prices.

The banks subject to the test remained above their minimum capital requirements in the test’s worst-case scenario, though they would collectively lose more than $600 billion, the Fed said.

Their capital ratios would decline to 9.7%, more than double their minimum requirements, according to the Fed. Bigger banks have additional surcharges that require them to hold higher levels of capital beyond the minimum.

The severely adverse scenario, as it is known, had U.S. unemployment rising to a peak of 10% in the third quarter of next year. It assumed a 40% decline in commercial real estate prices, a 28.5% drop in home prices, widening corporate bond spreads, a 55% decline in stock prices and increased market volatility.

This year’s hypothetical scenario is tougher than the 2021 test by design, the Fed said. Last year’s test found the 23 biggest U.S. banks would collectively lose more than $470 billion. Some smaller banks are only required to take the test every other year.

This year, the biggest banks in the country, including

JPMorgan Chase

& Co. and Bank of America Corp., saw their capital levels fall further than last year on higher loan and trading losses.

The economy’s swift and strong recovery from the pandemic helped big banks post record profits in recent years. Recession fears, however, are clouding their outlook. Inflation is at a 40-year high, and Fed Chairman

Jerome Powell

said this week that higher interest rates in response to rising prices could tip the economy into recession. Several bank executives have issued similar warnings in recent weeks.

How the banks perform in the tests determines how much capital they must sock away for potential trouble. Once they satisfy that requirement, they are able to return their excess capital to shareholders in buybacks and dividends.

Big U.S. banks will likely boost their dividend payouts soon, but total stock buybacks are expected to drop to $13 billion in the second quarter from $36 billion last summer and remain slow, Barclays analysts said in a research note.

The Fed temporarily barred stock buybacks and capped dividend payments in 2020, citing the need to conserve capital while the coronavirus pandemic took hold. Those restrictions were removed last summer.

The stress tests were introduced following the 2008-09 financial crisis, when the U.S. government bailed out some of the largest financial institutions. The results of the first tests helped restore investor confidence in the banking system.

Write to Charley Grant at [email protected] and David Benoit at [email protected]

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