Fed says banks can withstand 10% unemployment, 55% fall in stock prices in annual stress test

The Federal Reserve on Thursday projected the possibility of a clearer path ahead for banks than it did a year ago, but said 33 financial institutions it reviewed had passed the annual capital reserve stress test.

The Fed estimated potential losses of $612 billion for banks in their worst economic scenario, and said that even if it did, the banks would still be well enough to make loans to homes and businesses to keep the economy afloat. This is a more serious loss estimate of $50 billion than last year by the largest banks.

“This year’s hypothetical scenario is more stringent 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% increase in unemployment to 10%, a 40% fall in commercial real estate prices, and a 55% decrease in stock prices.

Under these conditions, the total proportion of public capital – a means of protection against losses – will fall by 2.7% to a minimum of 9.7%, which is twice the minimum requirement. In 2021, the expected decrease in the total share capital ratio was 2.4%.

After the test results, banks will be allowed to declare dividends and buy back shares from Monday, after the market closes.

Federal Reserve officials emphasized that the economic slowdown in the stress test is not a prediction of how the actual economy is expected to perform, but rather an assumption to measure the strength of banks.

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

Federal Reserve officials said that the banking system also has limited exposure to losses in the cryptocurrency markets and is expected to remain resilient despite the turmoil in the sector.

The public banking system started with 12.4% of the total combined capital. It fell a bit in 2022 but remained well above historical levels, such as 5% in 2009 and about 10% in 2012, according to Fed data.

The stress tests cover the largest US banks including JPMorgan Chase & Co. JPM,
-1.09%And the
Goldman Sachs Group Inc. GS,
+ 0.57%And the
American Express AXP,
-1.90%And the
Morgan Stanley MS,
-0.58%And the
Wells Fargo & Company WFC,
-1.81%And the
Bank of America Corp. BAC,
-1.60%
and Citigroup Inc. C,
-1.80%And the
As well as regional lenders.

Ahead of the results, bank stocks were mostly lower as Federal Reserve Chairman Jerome Powell testified for a second day before Congress and affirmed his commitment to fighting inflation.

JPMorgan Chase is down 1.1%, Goldman Sachs is up 0.6%, Citigroup is down 1.8%, and Bank of America is losing about 1.6%. Financial Choice Sector SPDR ETFS XLF,
-0.38%
It fell 0.4%.

Stress tests measure balance sheets against banks’ capital requirements as an indicator of their strength in the event of a potential economic downturn. The results then determine how much the capital banks will return to shareholders in the form of buybacks and dividends.

Ahead of the stress test results, Coin analyst Garrett Seiberg said Thursday he expects banks to pass, but warned of potential opposition from lawmakers.

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

Ian Katz of Capital Alpha said he anticipates some potential “hurdles” given the higher number of banks undergoing stress testing this year.

“This year’s exams are seen as a little more difficult than last year,” Katz said in a research note. “For example, the global market shock component of the scenarios could cause challenges for banks with significant international exposure.”

The latest findings reflect the Fed’s assessment of 33 US banks, up from 23 lenders last year. Banks with less than $250 billion in assets pass the exam every two years instead of every year, under rules adopted in 2020. Large regional banks such as Fifth Third Bancorp FITB,
-2.76%
and Ally Financial Inc. ALLY,
+ 1.15%
It was listed this year after taking vacation 2021.

The US Federal Reserve reshapes the terms of the tests each year, depending on the key economic factors on the central bank’s radar screen.

We see: Powell says the US economy can handle the upcoming additional interest rate hikes

Thursday’s stress test results point to the latest round of tests dating back to the Dodd-Frank Bank reform legislation that followed the 2008 global financial crisis.

In 2021, the Fed said that 23 of the largest banks operating in the United States would still have more than twice the capital required even with $474 billion in losses in a potential recession. This conclusion led the Federal Reserve to rescind the restrictions on buybacks and dividends it had introduced in response to the COVID-19 pandemic.

Read also: US banks will pay an additional $2 billion in quarterly dividends after the Federal Reserve’s green light

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