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The largest US banks have successfully passed the Federal Reserve’s annual assessments of their ability to withstand future economic and market crises, leading analysts to forecast a significant increase in dividends and share buybacks.
The Fed announced that under its “severely adverse” scenario—where unemployment rises to 10 percent—22 banks, including JPMorgan Chase, Goldman Sachs, and Bank of America, could face losses exceeding $550 billion.
Nonetheless, they would experience a substantially smaller impact on capital compared to previous years and would remain well above the required regulatory standards.
The hypothetical recession used to test the banks’ resilience was less severe than last year’s scenario. Although conceived before the return of President Donald Trump to office, it occurs at a time when his administration is advocating for a relaxation of financial regulations.
“Large banks remain well capitalized and resilient to a range of severe outcomes,” stated Michelle Bowman, the Fed’s vice-chair for supervision.
The findings from the Fed’s “stress tests” will determine the minimum capital levels that banks need in relation to their risk-adjusted assets, acting as a crucial buffer to absorb losses.
Jason Goldberg, an analyst at Barclays, projected that Goldman Sachs would emerge as the biggest beneficiary among major US lenders with its minimum capital level decreasing from 13.7 percent to 10.7 percent. Wells Fargo, M&T Bank, and Morgan Stanley are also expected to see their capital requirements lowered by 1 percentage point.
He noted that this is likely to enhance the surplus capital that many banks will return to shareholders through dividends and share buybacks. “We anticipate share repurchase (in dollars) to rise by 12 percent at the median bank compared to last year’s exam, with most banks remaining stable or increasing,” he mentioned.
Banks are optimistic that the tests will become even more lenient, especially after the Fed responded to a legal challenge from the primary banking lobby with a commitment to reform the exercise. Earlier this year, the central bank indicated plans to enhance transparency and to average test results over the past two years to lessen volatility.
Banks are required to wait until Tuesday to update their expectations regarding new capital requirements. They often outline plans for dividends and share buybacks after the Fed stress tests.
This year’s stress tests will reduce banks’ aggregate tier one capital ratio, their principal cushion against losses, by 1.8 percentage points—less than in past years and significantly below last year’s 2.8 percentage-point reduction.
However, the Fed indicated that it plans to calculate banks’ capital requirements based on its two-year averaging approach, assuming that it is finalized in the coming weeks. This will increase the capital impact to 2.3 percent. Bowman expressed that this change is preferable “to address the excessive volatility in the stress test results and corresponding capital requirements.”
The lender with the most significant capital decline due to the hypothetical stress was Deutsche Bank’s US subsidiary, which faced a theoretical drop of over 12 percentage points based on averaged results from the last two tests. The US subsidiaries of Switzerland’s UBS and Canada’s RBC followed with substantial declines. Nonetheless, all remained above the 4.5 percent minimum level throughout the exam.
This year’s “severely adverse” scenario projected a 7.8 percent decline in US GDP over a year, a 5.9 percentage-point rise in unemployment to 10 percent, and inflation slowing to 1.3 percent. House prices would fall by 33 percent, and commercial property values could drop by 30 percent.
While this would mark one of the most extreme recessions in history, it is less severe than last year’s scenario. The hypothetical market crash—characterized by a 50 percent drop in share prices and a sharp sell-off in high-yield bonds—was also milder than in last year’s assessment.
The Fed remarked that banks benefited from higher profitability and that it had incorporated lower hypothetical losses from private equity after “adjusting how these exposures are measured to better align with their characteristics.”
Under pressure to lighten regulatory demands for growth and investment, the Fed has initiated plans to reevaluate many of its banking regulations.
This week, the Fed and the two other major banking regulators divulged plans to reduce the enhanced supplementary leverage ratio, which dictates the capital requirements for the largest banks against their total assets.
