No Stress — Evening Brief – 06.27.24

The Federal Reserve released its annual bank stress test results on Wednesday after the bell, revealing that 31 major U.S. banks with at least $100 billion in assets all passed, indicating that they could withstand a hypothetical recession resulting in nearly $685 billion in losses; however, their financial stability is less secure compared to the previous year.

While the major banks saw higher hypothetical losses this year due to riskier holdings, the results were “within the range of recent stress tests.” Furthermore, each bank exceeded its minimum capital requirements during a hypothetical recession.

“The goal of our test is to help to ensure that banks have enough capital to absorb losses in a highly stressful scenario,” Fed vice chair for supervision Michael Barr said. “This test shows that they do.”

While no bank appeared to be significantly knocked off course this year which used approximately the same assumptions as the 2023 test, the group’s aggregate capital levels decreased 2.8 percentage points, worsening the decline from last year. The so-called common equity Tier 1 capital, the highest-quality regulatory capital, would bottom out at 9.9%, well above the 4.5% minimum requirement, regulators pointed out.

While all banks passed, the results differed. At JPMorgan, the largest US bank, the CET1 ratio would fall to 12.5% from 15% by the end of the year. Among the megabanks, Wells Fargo’s CET1 fell to the lowest level of 8.1%, down from 11.4% at the end of the year. However, given that the ratios are so far above the minimum, they are likely to have a stronger argument against further large hikes.

This year’s “severely adverse” scenario predicted a 10% increase in U.S. unemployment, a 55% loss in equity prices, and a 40% drop in commercial real estate prices. As with the previous year, a subset of banks with big trading businesses experienced an additional “global market shock” component that included equity price drops, a sharp rise in short-term U.S. Treasury yields, and a weaker dollar.

The results underscore “the usefulness of the extra capital that banks have built in recent years above their minimum requirements,” Barr said. “Because of that extra capital cushion, we expect that large banks would be able to continue extending credit to households and businesses during a time of financial stress.”

Capital requirements have been the subject of intense debate in Washington in the year since the last stress test. Last July, the Fed and other regulators revealed a long-awaited plan for stricter restrictions, which they claimed would result in a 16% increase for banks with more than $100 billion in assets. But given the relative calm in the banking sector, this push was quickly abandoned.

Bank executives launched a lobbying campaign, claiming they already have sufficient capital and that the new requirements would harm consumers and companies. They lobbied for major amendments or abandoning the plan entirely, and they were successful: earlier this year, Fed Chair Jerome Powell stated that there would be “broad and material changes.”

Nonetheless, on Wednesday, Barr stressed the importance of banks holding on to additional capital. He ascribed the increased losses this year to higher credit card balances and delinquencies, riskier corporate credit portfolios, and a combination of higher expenditures and lower fee revenue in recent years, which resulted in less net income to offset losses. These three criteria “suggest required capital buffers should be larger.”