The Federal Reserve’s latest stress tests show that the largest US banks could withstand a severe recession with plenty of capital on hand to absorb hundreds of billions in losses.
This year the Fed’s regulatory exam applied to 22 banks with assets of more than $100 billion, a group that included Wall Street giants such as JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS), and Morgan Stanley (MS).
“Large banks remain well capitalized and resilient to a range of severe outcomes,” the Fed’s vice chair for supervision Michelle Bowman said.
All 22 lenders were able to show that their capital levels would stay above a key threshold in a scenario where GDP contracts by nearly 8%, unemployment soars to 10%, home prices plunge 33%, and the stock market drops by 50%.
Their common equity tier 1 capital ratio as a group was 11.6%, well above the required minimum of 4.5%.
The banks’ losses in this simulation also collectively amounted to more than $550 billion. That included $148 billion from credit card losses, $124 billion from business loans, and $52 billion from commercial real estate.
The passing grade for all banks could help the Trump administration make its case that it is time to loosen rules for financial institutions as it implements a deregulatory agenda it hopes will boost lending and drive economic growth.
Earlier this week, US regulators proposed one of the most dramatic rollbacks of bank capital rules since the 2008 financial crisis as they suggested altering the so-called enhanced supplementary leverage ratio (eSLR).
Banks have complained that this ratio penalizes them for holding lower-risk assets such as Treasury bonds.
More regulatory changes for big banks could still be on the way. Bowman, the Fed’s top banking regulator appointed by Trump, made it clear in a speech Monday that revisiting the eSLR requirement is just the start of broader capital rollback considerations.
“More work on capital requirements remains, especially to consider how they have evolved and whether changes in market conditions have revealed issues that should be addressed,” she said.
Other capital requirements under consideration for adjustment include the surcharge on global systemically important banks and the asset thresholds that define how strict regulatory standards are for each institution.
On July 22, the Fed will host a conference to bring together leaders to discuss the capital framework for US banks.
JPMorgan CEO Jamie Dimon has asked the administration to consider a broad set of changes. Among the biggest Wall Street banks, JPMorgan had the highest level of capital under the Fed’s stressed scenario.
“We expect to see additional regulatory relief measures announced for the banking industry in the coming months,” said RBC banking analyst Gerard Cassidy. “Regulatory relief will likely lead to higher bank profitability and increased merger and acquisition activity.”
The Fed tests were first mandated annually by law following the 2008 financial crisis as a way of assessing the stability of the nation’s giant lenders.
There will also likely be changes to these Fed tests in future years. The Fed is seeking public input on the models used to determine the hypothetical losses and revenue of banks under stress, and it will use that feedback to make improvements going forward.
Banks showed a smaller decline in capital under the stressed scenario this year than in years past, which the Fed says is due to volatility in the models and milder deterioration in the economy. Loan losses were also lower this year.
Lenders typically use the results of the annual Fed tests to determine how much they should have on their balance sheet to absorb shocks and how much they have left over for dividends and buybacks.
The Fed has asked banks not to make announcements about how much money they plan to return to shareholders until early next week.
In a note earlier this week, Wells Fargo analyst Mike Mayo indicated that good stress test scores for the biggest banks would give a “green light” for these lenders “to deploy more capital for loans, deals, and buybacks.”
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