US Banks Face Bigger Losses but Pass Fed's Stress Test with Flying Colors

In the face of more stringent challenges, US banks have proven their resilience. The Federal Reserve's annual stress test revealed that the largest banks have the capital reserves necessary to weather a severe economic downturn, ensuring their stability even in turbulent times.

Understanding the Stress Test

Think of the stress test as a rigorous health check for banks. The Federal Reserve evaluates how banks would fare under dire economic conditions. This year's hypothetical scenario included soaring unemployment, a volatile stock market, and a housing market crash. Despite these severe conditions, the banks demonstrated they had sufficient capital to continue lending to consumers and businesses.

Key Findings

The Fed's analysis showed that all 31 major banks would remain solvent in a severe economic crisis, boasting robust high-quality capital levels. Even at their lowest, these levels would be 9.9%, more than double the required minimum.

What Lies Ahead?

With positive results in hand, banks are now poised to announce plans for returning capital to shareholders via stock buybacks and dividends, starting after the market closes on Friday.

Financial expert Chris Marinac remarked, "We were pleasantly surprised by the results. It shows that banks are in good health."

Steeper Hypothetical Losses

This year's stress test did highlight larger potential losses for banks, a consequence of riskier investments. The combined hypothetical losses amounted to $685 billion, with an average capital drop of 2.8 percentage points—the steepest decline since 2018.

Top Performers

Among the top performers, Charles Schwab led with a 25.2% capital ratio in the severe scenario. Other strong contenders included Bank of New York Mellon, JPMorgan Chase, Morgan Stanley, Northern Trust, and State Street. Even the US branches of Deutsche Bank and UBS performed admirably.

Conversely, smaller regional banks such as BMO, Citizens Financial Group, and HSBC had capital levels closer to the required minimum.

Industry Reaction

The banking sector views these results as a testament to its strength, arguing against the necessity for additional regulations. Rob Nichols, CEO of the American Bankers Association, stated, "The strength and resilience of the banking sector show that more regulations are unnecessary."

Areas of Concern

Credit cards emerged as a significant source of losses, accounting for over a quarter of the hypothetical losses. Credit card balances have surged by over $100 billion in the past year, with an increasing number of delinquencies.

Corporate loans, particularly to riskier businesses, also posed challenges, with a default rate three times higher than that of safer loans.

Changes in Bank Income

The Fed noted a decline in banks' non-interest income, such as fees, while their expenses, including salaries and real estate costs, remained steady.

Final Thoughts

The annual stress test plays a crucial role in determining the amount of capital banks must hold in reserve. Any excess can be returned to shareholders. This year's results affirm that, despite facing greater challenges, banks are robust enough to endure a severe economic downturn. This resilience is reassuring for everyone, as it ensures banks can continue to support the economy by lending to consumers and businesses.

Stay tuned as banks unveil their capital return plans, signaling confidence in their stability and future prospects.