The annual stress test results of the Federal Reserve show that in a series of "extremely unfavorable" economic scenarios where the US unemployment rate soared to 10%, the stock market value plummeted by 55%, and commercial real estate prices plummeted by 40%, all 31 participating banks in the test did not fall below the bottom line of the minimum capital requirements, demonstrating the resilience and stability of the US banking industry in the face of potential economic risks. The banking industry is very optimistic about this and has increased its share buyback efforts, and there is also a possibility of a trend towards a more relaxed regulatory environment.
Top American banks have turned in satisfactory answers in the Federal Reserve's annual stress test, opening the door not only to improving shareholder returns, but also indicating that the banking industry may face a more lenient capital regulatory environment.
On Wednesday, June 26th, Eastern Time, the Federal Reserve released the results of its annual stress test. The results showed that all banks participating in the test did not fall below the bottom line of the minimum capital requirement in a simulated economic downturn, although these banks may face losses as high as $685 billion. However, this number is still within an acceptable range for stress tests in recent years.
This year's annual stress test covered 31 large banks with massive assets, and the test considered a series of "extremely unfavorable" economic scenarios, including a surge in US unemployment to 10%, a 55% plunge in stock market value, and a substantial 40% drop in commercial real estate prices. Even under the assumed extreme economic pressure, these banks' Tier 1 common equity ratios are expected to reach a minimum of 9.9%, a significantly higher number than the minimum standard of 4.5% set by regulatory agencies.
The test results further demonstrate the resilience and stability of the US banking industry in the face of potential economic risks. Banks have demonstrated sufficient capital buffers, which not only increase market confidence in the banking industry but also provide important reference for policy makers as discussions continue on reducing capital gains to 5%.
Michael Barr, vice chairman of the Federal Reserve's regulatory agency, expressed affirmation and pointed out:
"Our stress tests are designed to ensure that banks have sufficient capital to withstand losses in extreme economic conditions. The test results are encouraging and confirm the stability of the banking system."
Banks still need to further increase capital buffers to resist future risks.
The stress test results also show that although all banks have met regulatory requirements, there are significant differences in the degree of capital level changes among different banks. JP Morgan's CET1 ratio fell slightly from 15% at the beginning of the year to 12.5%. Wells Fargo's CET1 ratio dropped significantly from 11.4% at the beginning of the year to 8.1%, the lowest level among all large banks. This result highlights the differences in capital management strategies and risk mitigation capabilities within the banking industry.
When facing "global market shocks," including a drop in stock prices, a sharp rise in short-term bond yields, and a depreciation of the US dollar, large American banks have demonstrated the power of their accumulated additional capital. Although the capital adequacy ratio of banks far exceeds the minimum regulatory requirements, Barr still emphasized the need for banks to maintain a high level of capital. He pointed out:
"This result highlights the importance in recent years of capital buffers that have been higher than the minimum regulatory requirements for banks. These additional capital buffers make us believe that large banks can continue to provide necessary credit support to households and businesses during financial turmoil. This not only enhances banks' ability to withstand risks, but also provides a solid foundation for the stability and development of the economy."
In addition, Barr attributed the higher potential losses shown in this year's stress test to several key factors, namely the rise in credit card balances and delinquency rates, the increased risk exposure of corporate loans, and the cost increase and reduction of fee income in recent years. These factors have jointly compressed banks' net income and reduced their ability to absorb losses. Barr believes that:
"Given these factors, banks should further increase their capital buffers to ensure stability and have sufficient capital to support households and businesses' demand for credit in the face of economic stress."
The Federal Reserve is considering reducing the increase in capital gains to 5%, and the American banking industry is stepping up its stock buyback momentum.
Since the last stress test, discussions on the adequacy of bank capital have triggered extensive and in-depth debates at the policy-making level. After the Federal Reserve announced more stringent capital requirements for banks with assets over $100 billion last July, Wall Street's banking industry launched a very intense lobbying campaign to alleviate the pressure of the new regulations. Bank executives believe that they have met the capital adequacy requirements, and new regulatory rules may have a negative impact on consumers and businesses. They actively seek important modifications to the proposal or seek a complete revocation. Federal Reserve Chairman Jerome Powell said earlier this year that he will make "broad and substantive adjustments" to the proposal.
On June 25th, the Federal Reserve recently submitted a proposed draft revision to the Federal Deposit Insurance Corporation and the Monetary Audit Office, planning to lower the capital increase requirement proposed last year to 5%. This proposal aims to ease the capital pressure on the banking industry, but according to media reports, there is no consensus within the regulatory authorities about this revision, and the possibility of completing the revision plan before the November presidential election in the United States is unclear.
Although discussions at the regulatory level are still ongoing, the major banks in the United States have shown confidence in their own capital levels. These banks have increased their share buyback efforts this year, even before the stress test results were announced. Specifically, in the first quarter of 2024, the six largest banks' stock repurchase exceeded $14 billion, a substantial increase of 73% compared to the repurchase speed in the second half of last year. This measure not only reflects the banking industry's confidence in its own stable capital situation, but also reflects their optimism about future market development.
The Federal Reserve said on Wednesday that it hoped banks would wait until 4:30 p.m. on Friday to announce any plans regarding dividends and share buybacks. The purpose of doing so is to give the market more time to digest and understand the impact of these plans.
In recent months, several banks' executives have claimed to have excess capital. This includes JPMorgan's unexpected dividend growth, with JPMorgan CEO Jamie Dimon saying this is because "our capital cup runneth over." This statement means that banks have more capital than they need, so they can use this extra capital to increase shareholder returns, such as by increasing dividends.
A senior official at the Federal Reserve said that, based on the results of the stress tests, the banking sector's required stress capital buffer (i.e. additional capital used to keep banks stable under economic stress scenarios) will generally increase moderately. This means that although banks are currently well-capitalized, regulatory authorities still hope that they will hold more capital as a safety cushion to better cope with possible future economic pressures.
Editor/Emily