Fed says banks can easily weather deep recession

© Reuters. The exterior of the Marriner S. Eccles Federal Reserve Building is seen in Washington, DC, U.S., June 14, 2022. REUTERS/Sarah Silbiger

by Pete Schroeder and Michelle Price

WASHINGTON (Reuters) – The U.S.’s largest lenders will remain well-capitalized in the event of a severe economic shock, paving the way for them to issue share buybacks and dividends, the Federal Reserve said on Thursday after its annual health checks on banks.

The Fed said the 34 banks with more than $100 billion in assets overseen by the Fed would suffer a combined $612 billion in losses under a hypothetical deep recession. But that would still leave them with roughly twice as much capital as their rules would require.

Thus, including JPMorgan Chase (NYSE: ), Bank of America (NYSE: ), FuGuo bank (New York Stock Exchange:), Citigroup (New York Stock Exchange:), Morgan Stanley (NYSE: ) and Goldman Sachs (NYSE: ) can use their excess capital to issue dividends and buybacks to shareholders.

In an annual “stress test” campaign established after the 2007-2009 financial crisis, the Fed assesses how banks’ balance sheets will respond to a hypothetical deep recession. The results determine how much capital banks need to stay healthy and how much they can return to shareholders.

Banks will have to wait until the market closes at 4:30 p.m. ET (2030 GMT) on Monday before announcing their capital allocation plans.

While the 2022 scenarios were devised before Russia’s invasion of Ukraine and the current prospect of hyperinflation, they should reassure investors and policymakers that the country’s banks have warned economists that the U.S. later this year or next year We are well prepared for a possible recession.

In this year’s scenario, 34 banks are hit hard, the economy shrinks by 3.5%, due in part to a collapse in the value of commercial real estate assets, and unemployment jumps to 10%. Check out an explainer on stress testing here:

But even so, the Fed said the bank’s total capital ratio was still about double the minimum amount required by regulators.

strong performance

In 2020, the Fed changed how the test works, eliminating the pass-fail model and introducing a more nuanced, bank-specific capital regime.

The test assesses whether banks will remain above the required minimum capital ratio of 4.5%, providing a buffer against potential losses. Well-performing banks typically go well above this level.

The Fed said the average capital ratio of the 34 banks was 9.7%. It was 10.6% last year, when the Fed conducted a slightly accommodative test of 23 lenders.

“The stress test shows that the largest U.S. bank is strong and a source of stability for an economy facing some notable headwinds in the coming months,” said Isaac Boltansky, head of policy research at brokerage BTIG.

Huntington Bancshares Incorporated (NASDAQ: ) had the lowest ratio at 6.8%, while Deutsche Bank (ETR:) had the highest ratio at 22.8%.

The test also sets each bank’s “stressed capital buffer,” or additional capital buffer above the regulatory minimum, the size of which depends on each bank’s hypothetical losses in the test. The Fed will announce these buffers in the coming months.

Analysts at Credit Suisse this week estimated that the average stressed capital buffer for large banks will be 3.3%, up from 3.2% in 2021, and range from 2.5% to 6.3%.

They also estimate that by 2022, the amount reallocated by capital lenders to shareholders will be down about 10% from a year earlier.

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