Fed says banks could withstand 10% unemployment, 55% stock price drop in annual stress test

The Federal Reserve Board on Thursday projected the potential for a more difficult path for banks than a year ago, but said the 33 financial institutions it reviewed passed the annual stress test on capital reserves.

The Fed estimated $ 612 billion in potential losses for banks in their worst economic scenario, and said that even if that were to happen, banks would still be healthy enough to offer loans to households and businesses to maintain. the floating economy. This is a projection of $ 50 billion more serious losses than a year ago by the largest banks.

“This year’s hypothetical scenario is tougher than the 2021 test, by design, and includes a severe global recession,” the Fed said in a statement.

The Fed’s model included a 5.75% rise in unemployment to 10%, a 40% drop in commercial real estate prices and a 55% drop in stock prices.

Under these conditions, the aggregate share capital ratio — a cushion against losses — would fall by 2.7% to a low of 9.7%, which is double the minimum requirement. In 2021, the projected fall in the aggregate ordinary capital ratio was 2.4%.

Following the test results, banks will be allowed to announce dividends and share repurchases starting Monday, after the market closes.

Federal Reserve officials stressed that the economic slowdown in the stress test is not a projection of how the economy is expected to actually work, but rather a hypothetical one to measure the strength of banks.

The stress test also resulted in more than $ 450 billion in loan losses and $ 100 billion in business and counterparty losses.

The banking system also has limited exposure to losses in the crypto markets and is expected to remain resilient despite unrest in the sector, Fed officials said.

The banking system started the year with an aggregate ordinary capital ratio of 12.4%. It has fallen slightly in 2022, but remains well above historical levels, such as 5% in 2009 and around 10% in 2012, according to Fed data.

Stress tests cover the largest U.S. banks, including JPMorgan Chase & Co. JPM,
Goldman Sachs Group Inc. GS,
+ 0.57%,
American Express Co. AXP,
Morgan Stanley MS,
Wells Fargo & Co. WFC,
Bank of America Corp. BAC,
and Citigroup Inc. C,
as well as regional lenders.

Prior to the results, banks ’shares were mostly lower, as Fed Chairman Jerome Powell declared a second day in Congress and reiterated his commitment to fighting inflation.

JPMorgan Chase was down 1.1%, Goldman Sachs was up 0.6%, Citigroup was down 1.8% and Bank of America was down 1.6%. The Financial Select Sector SPDR ETFS XLF,
fell 0.4%.

Stress tests measure balance sheets with banks ’capital requirements as an indicator of their strength in a possible economic downturn. The results then shape the amount of capital that banks will return to shareholders in the form of repurchases and dividends.

Ahead of the results of the stress tests, Cowen analyst Jaret Seiberg said on Thursday he expected banks to approve, but warned of a possible setback by lawmakers.

“The political risk today is that Capitol Hill is questioning why banks should distribute any capital if a recession is possible,” Seiberg said. “We don’t see it winning the day, but it could get attention.”

Ian Katz of Capital Alpha said he expects some potential “inconveniences” given the greater number of banks undergoing stress testing this year.

“This year’s tests are considered a little tougher than last year’s,” Katz said in a research note. “For example, the shock element of the global scenario market could pose challenges for banks with a lot of international exposure.”

The latest results reflect the Fed’s assessment of 33 US banks, more than last year’s 23 lenders. Banks with less than $ 250 billion in assets take the exam every two years instead of every year, according to rules adopted in 2020. Large regional banks such as Fifth Third Bancorp FITB,
and Ally Financial Inc. ALLY,
+ 1.15%
are included this year after taking off in 2021.

The U.S. Federal Reserve reshapes test conditions each year, based on key economic factors on the central bank’s radar screen.

I will see: Powell says the U.S. economy can cope with the additional rate hikes that are approaching

The results of Thursday’s stress tests mark the final round of examinations dating back to the Dodd-Frank banking reform legislation that followed the 2008 global financial crisis.

In 2021, the Fed said 23 of the largest banks operating in the U.S. would still have more than double the capital needed, even with losses of $ 474 billion in a possible recession. This finding led the Fed to remove restrictions on repurchases and dividends it introduced in response to the COVID-19 pandemic.

Also read: US banks will pay an additional $ 2 billion in quarterly dividends after the Fed’s green light

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