The US Federal Reserve further loosened restrictions on dividends and buybacks by America’s biggest banks as it released an analysis showing the lenders could suffer almost $500bn in losses and still comfortably meet capital requirements.
Twenty-three banks, including JPMorgan Chase and Goldman Sachs, underwent “stress tests” by the Fed that modelled the financial damage from a series of doomsday scenarios. These included a US stock market crash, a steep drop in economic output, and substantial distress in commercial real estate.
The results, released on Thursday, will pave the way for billions of dollars in stock buybacks and dividends, which bank investors have been eagerly anticipating.
“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.
The annual stress tests showed the country’s largest lenders could withstand $474bn in losses from loans and other positions, and still emerge with more than double the required high-quality common equity tier one, or CET1, capital relative to their risk-weighted assets.
Of those headquartered in the US, investment banking groups Goldman Sachs and Morgan Stanley suffered the biggest hits to their capital ratios in the stress tests, with declines of 5.9 and 4.7 percentage points, respectively.
This compared to an average decline of 2.4 percentage points for the 23 banks that underwent the tests, which included the American subsidiaries of foreign banks with significant US operations.
Consumer debt accounted for a smaller portion of overall losses than previous years since most retail customers spent the past year paying down credit cards and other loans during the Covid-19 pandemic. But an increase in expected losses in commercial and industrial loans more than offset that decline. Nearly $160bn of the losses came from commercial real estate and corporate loans.
The Fed capped dividends and banned stock buybacks last year at the outbreak of the pandemic. The central bank loosened some of these restrictions at the start of 2021, but still limited the amount of money banks could return to shareholders to no more than the cumulative profits of the prior four quarters.
The Fed had previously said it would pull back these limits further pending the results of the annual stress tests published on Thursday, which are a requirement of the Dodd-Frank financial regulations introduced in the wake of the crisis.
The big banks have been bolstered by government stimulus and buoyant revenues from trading and dealmaking and their capital levels have also swelled in part due to the restrictions on shareholder payouts.
The Fed expects banks to wait until Monday to analyse the results of the stress tests before announcing any plans for new shareholder payouts, according to senior Fed officials.
Barclays analysts estimate the median bank out of the 20 relevant institutions it covers will return over 100 per cent of its earnings to shareholders over the next year, with capital returned to investors approaching $200bn.
From the tests, the Fed will also prescribe for each bank how much CET1 capital in excess of regulatory minimums they need to keep through a so-called stress capital buffer. The CET1 ratio measured against risk-weighted assets is a crucial benchmark of financial stability.
Banks typically aim to keep capital in excess of regulatory minimums.