Banks In A Strong Position To Withstand Economic Turbulence

Exerpt from Friday, June 26, 2020

Washington Wrap

by Maria Rafi of Market Intelligence

The Federal Reserve's highly anticipated annual bank stress tests this week showed that banks are in a strong position to withstand further economic turbulence in case the coronavirus takes a turn for the worse, but banks were also restricted from spending more capital on shareholder distributions.

In an effort to reduce the amount of capital leaving the banking system, the Fed is not allowing large banks to buy back their shares in the third quarter. However, the Fed is still letting banks pay dividends to shareholders, although it is capping dividends at second-quarter levels and only allowing banks to pay them if they earned enough money.

The regulator also asked banks to submit their capital plans again later this year and will evaluate quarter by quarter whether more changes to capital distributions are needed.

The decision not to prohibit dividends across the board met some opposition at the Fed. Governor Lael Brainard, an Obama administration appointee, argued that failing to impose a wide suspension of dividend payments showed that regulators had not learned from the 2008 financial crisis. She stressed that big banks should take immediate steps to preserve capital so "they can be a source of strength in a robust recovery."

The Fed's additional COVID-19-related analysis tested banks against three distinct scenarios for the future path of the U.S. economy, although the Fed cautioned that none of them were forecasts. The scenarios tested banks against a rapid V-shaped recovery, with the economy almost back at full strength by the end of 2020; a slower U-shaped recovery; and a W-shaped recovery where a second wave of the virus leads to another severe drop in economic activity.

Individual bank results using these coronavirus scenarios were not released, though the Fed did disclose banks' capital ratios and potential losses under the Fed's pre-pandemic severely adverse scenario.

The Washington Wrap is a weekly recap of financial regulation, news and chatter from around the capital. This article was published by S&P Global Market Intelligence.