US Banks Pass Fed Stress Test Despite Steeper Losses

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In its latest annual stress test, the Federal Reserve revealed that the largest U.S. banks have sufficient capital to withstand severe economic and market challenges. Despite facing increased hypothetical losses this year due to riskier portfolios, the stress test affirmed that these banks could weather spikes in unemployment rates, market volatility, and significant declines in mortgage markets while still maintaining adequate capital reserves for lending purposes.

According to the Fed’s findings, even under extreme scenarios, the banks’ high-quality capital would only dip to a minimum of 9.9%, significantly above the regulatory minimum requirements. This positive outcome paves the way for banks to proceed with announcing their capital plans, including potential stock buybacks and dividends, which they can reveal to shareholders after the market closes on Friday.

Chris Marinac, Director of Research at Janney Montgomery Scott, expressed optimism about the results, noting that losses were lower than expected despite challenges in areas like commercial real estate. This underscores the overall robust health of the banking sector.

However, the stress test did highlight that banks experienced greater losses this year compared to previous assessments, attributed to shifts in their portfolio compositions. The banks tested collectively projected losses amounting to $685 billion in the severe scenario, with average capital ratios declining by 2.8 percentage points, marking the steepest drop since 2018.

Among the banks tested, Charles Schwab Corp demonstrated the highest capital resilience with a 25.2% capital ratio under stress, followed by other major institutions like JPMorgan Chase, Morgan Stanley, and Bank of New York Mellon, all maintaining double-digit ratios. In contrast, smaller regional banks such as BMO, Citizens Financial Group, and HSBC showed stressed capital ratios closer to the minimum requirements.

The stress test outcomes also revealed insights into specific areas of vulnerability, notably credit cards, which accounted for a significant portion of projected losses due to increased balances and delinquency rates. Banks like Ally Financial and Capital One reported substantial losses on their credit card portfolios, underscoring challenges in this sector.

Moreover, the Fed highlighted concerns about banks’ corporate credit exposures, noting a shift towards riskier loans with higher default probabilities, particularly in non-investment grade corporate credits. These loans were projected to contribute significantly to overall losses in the stress test scenario.

Looking ahead, while the banking industry celebrated the resilience demonstrated in the stress test results, criticisms persisted regarding regulatory efforts to impose higher capital standards. The Fed’s scrutiny on non-interest income declines and rising non-interest expenses further underscored ongoing challenges for banks in maintaining profitability amidst economic uncertainties.

Overall, while the stress test reaffirmed the solidity of major U.S. banks, it also provided critical insights into areas needing attention, especially amidst evolving economic conditions. The results will guide regulatory decisions and impact how banks manage capital and return excess funds to shareholders in the coming months.