The Fed said it is requiring all 34 big banks that participated in the exercise to resubmit their capital plans.
The Federal Reserve announced Thursday that it is suspending stock buybacks at large banks and capping the dividends they can pay to shareholders to ensure the firms have enough loss-absorbing capital to keep lending during the coronavirus pandemic.
The Fed, in announcing the results of its annual stress tests, said it is requiring all 34 big banks that participated in the exercise to resubmit their capital plans because the economic outlook is so uncertain. In previous years, that has only been required for banks that didn’t pass the tests.
“For the first time in the ten years we have been doing stress testing, we are exercising the option that has always been in our capital framework of requiring all large banks to reassess their capital needs,” Fed regulatory chief Randal Quarles said in a statement. “The Board will use this information to make a further assessment of the banks’ financial conditions and risks.”
The stress tests, known as the Comprehensive Capital Analysis and Review, examine every year whether the largest banks would be able to weather rough economic headwinds with sufficient capital, based on hypothetical recession scenarios.
This is the first year that banks didn’t pass or fail based on whether their loss-absorbing capital was sufficient; instead, the amount that their capital dropped under the exercise will determine their capital requirements for the following year, along with however much they plan to pay in dividends.
Beyond the regularly scheduled 2020 stress test, the Fed also examined how big banks would perform under three possible economic futures relevant to the current recession: a quick recovery, a gradual recovery and a quick recovery followed by a second severe drop from another coronavirus lockdown.
“The banking system has been a source of strength during this crisis,” Quarles said, “and the results of our sensitivity analyses show that our banks can remain strong in the face of even the harshest shocks.”
As in previous years, the Fed announced how individual banks had fared under the hypothetical recession scenario, devised before the coronavirus pandemic led to lockdowns across the country.
It only released aggregate information from the special coronavirus-related analysis, but the aggregate information suggests that under at least the double-dip recession scenario, roughly a quarter of banks would breach their minimum capital requirements.
Under a “V-shaped recovery” envisioned by the Fed, banks’ core capital ratios remain “well above” the minimum 4.5 percent requirement, with the 25th percentile coming in at 7.5 percent.
“However, under the U-shaped or W-shaped alternative downside scenarios, a number of firms could experience significant capital depletion and several would approach minimum capital requirements,” the Fed said.
A senior Fed official cautioned against reading too much into this fact because the sensitivity analyses were limited in scope and, for example, did not incorporate the effects of actions already taken by Congress, including stimulus checks and expanded unemployment insurance.
Dividends will be capped based on either the amount the bank paid out in the second quarter or the average of its earnings over the four quarters ending with the quarter that ends next week, whichever is lower. Under certain scenarios, this could allow some banks to decrease their capital.
Fed Governor Lael Brainard dissented against this approach to dividends.
“This is a time for large banks to preserve capital, so they can be a source of strength in a robust recovery,” Brainard said in a statement. “I do not support giving the green light for large banks to deplete capital, which raises the risk they will need to tighten credit or rebuild capital during the recovery. This policy fails to learn a key lesson of the financial crisis.”