All 23 US banks that participated in a new Federal Reserve stress test would be able to withstand a severe global recession, demonstrating the strength of the largest financial institutions at a time when the banking industry still finds itself on shaky ground .
Results released by the Fed on Wednesday show that these banks would have enough capital to absorb losses and continue lending even if unemployment hit 10% and the stock market fell 45%.
Your projected losses would be $541 billion in this hypothetical scenario.
The largest of the group – JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS) and Morgan Stanley (MS) – would all have significantly larger capital buffers than the Fed's minimum requirement of 4.5% in this extreme scenario.
The same is true for the mid-sized regional banks that participated in this test, including PNC (PNC), Truist (TFC) and M&T (MTB).
“Today's results confirm that the banking system remains strong and resilient,” said Michael Barr, the Fed's vice chairman for oversight.
“At the same time, this stress test is just one way to measure that strength. We should remain humble about how risk can arise and continue our work to ensure banks are resilient to a range of economic scenarios, market shocks and other stresses.”
However, the results within the industry varied greatly. The bank with the highest capital ratio in the Fed's “very adverse scenario” was Charles Schwab (SCHW), one of the lenders that faced intense investor scrutiny earlier in the year while other banks faltered.
The bank with the lowest ratio was Citizens Financial (CFG), a regional bank based in Rhode Island. Other regional banks such as US Bancorp (USB) and Truist also ended the test with lower buffers than their major peers.
But the industry giants also posted the largest projected net income losses under the Fed's “very adverse scenario,” led by Citigroup at $34.9 billion. Wells Fargo had $32.9 billion and JPMorgan had $30.1 billion.
Goldman, perhaps the most famous name on Wall Street, had the highest estimated losses on commercial real estate loans and credit cards.
It also posted the heaviest losses in separate Fed assessments of how the largest banks' trading books would fare under “global and exploratory market shocks.”
The Fed's test, an annual industry rite since the 2008 financial crisis, is the first to be released since the banking world was rocked by riots following the failures of First Republic, Silicon Valley Bank and Signature Bank this spring.
Banks typically use the results of annual Fed stress tests to determine how much they should have on their balance sheets to cushion shocks and how much to spare for dividends and buybacks. Some banks are expected to announce late Friday how much money they now intend to return to shareholders.
However, banks are also preparing for the Fed's new higher capital requirements, which will force some of them to hold even larger buffers against losses.
Those tougher rules were already in the works before several regional banks collapsed in the spring, but regulators have made it clear in the wake of these troubles that they wanted to make sure their new approach could be applied to mid-cap institutions of a similar size in the First Republic or a Silicon Valley Bank. Both had assets of more than $200 billion at the time of their bankruptcy.
Federal Reserve Chairman Jerome Powell said last week he doesn't expect smaller community banks to be subject to the higher capital requirements, which are likely to be proposed sometime this summer. Institutions with at least $100 billion in assets may need to comply.
Forcing banks to accumulate larger buffers has pros and cons for lenders, regulators and the economy. This increases the stability of these institutions, but also makes it more difficult to generate robust profits and could lead banks to withdraw certain types of lending.
Powell discussed this balance last week.
“It's always a compromise,” he said. “More capital means more stable, resilient banking systems. It can also lead to lower credit availability at the fringes…there's no perfect way to assess that balance.”
Deputy supervisor Barr said last week the Fed is also considering “reverse stress tests,” which could be used as a tool to make banks more resilient by helping supervisors spot more exogenous issues that could go wrong, rather than patterns the past supervisors were trained to catch.
Take a test
The Fed first began applying stress tests to a broad group of banks in 2009, while the last financial crisis was still raging.
Under legislation passed in 2010, it became a statutory requirement annually for institutions with assets in excess of $100 billion. A law passed in 2018 adjusted the tests to the size of banks, meaning banks in the $100 billion to $250 billion range would be tested every other year.
Democrats and regulators criticized that 2018 adjustment, arguing it could have helped prevent the problems piling up at Silicon Valley Bank, which had not been stress tested before it failed.
Some in this year's test — BMO Financial, Citizens, M&T, and RBC US Group — were among the biannual banks not scheduled to be retested until 2024.
But the Fed required BMO, Citizens and M&T to be retested in 2023, and RBC also agreed for the 2023 test. All four banks had equity capital of 6.4% or more, which was above the 4.5% required.
This year, the Fed examined how 23 banks would fare in a severe global recession that also hit commercial real estate severely. In such a scenario, unemployment rises to 10%, home and commercial property prices fall about 40%, the stock market plunges 45%, market volatility rises, and corporate bond yields rise.
All 23 banks would have lost a total of 541 billion US dollars. Yet they would still have capital equal to 10.1% of total risk-weighted assets. Well above the 4.5% required by the Fed.
The biggest losses
Total projected losses of $541 billion include more than $100 billion from commercial real estate and residential mortgages and $120 billion from credit card losses, both higher than the losses projected in last year's test.
The banks with the largest CRE losses were Goldman with $16 billion, followed by Morgan Stanley ($13.7 billion) and Citizens ($12.4 billion).
Goldman also had the highest credit card losses at $24.7 billion, followed by Capital One ($22.2 billion) and TD Group ($21.4 billion).
Eight banks with large trading operations were also tested for a “global market shock” related to their trading positions. For the first time, this year's test also tested these banks' trading books against a second “exploratory market shock.”
The Fed said the global market shock was a severe recession with inflation expectations dwindling; The exploratory market shock tested a less severe recession with greater inflationary pressures.
The results of this research showed that the trading books of the largest banks have been resilient in an environment of rising interest rates.
Goldman suffered the largest forecast losses, losing $21.2 billion in the global market shock scenario and $18.1 billion in the exploratory market shock component.
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