Big US banks to pass stress test

Major US banks are expected to demonstrate sufficient capital to withstand any potential turbulence in the banking sector during the Federal Reserve’s stress tests this week. However, analysts predict that investor payouts may decrease slightly as a result. The stress tests, which assess the capital needed by banks to endure severe economic downturns, play a crucial role in banks’ capital planning and determine the amount of cash they can distribute to shareholders through dividends and share buybacks. This year’s tests follow the banking crisis that occurred earlier in the year, leading to the failure of Silicon Valley Bank and two other lenders.

While Wall Street giants like Citigroup, Bank of America, JPMorgan Chase, Goldman Sachs Group, Wells Fargo, and Morgan Stanley typically attract the most attention, smaller lenders such as Capital One, U.S. Bancorp, and Citizens are likely to be under scrutiny as well due to ongoing investor concerns about the sector. Despite the challenging nature of this year’s stress test, industry analysts and executives anticipate that the 23 participating lenders will demonstrate capital levels exceeding regulatory requirements.

Last year, the Fed projected that banks would face approximately $612 billion in losses in a severe economic downturn, still leaving them with double the capital required by regulatory standards. This year’s stress test is even more stringent, envisioning a 6.5-percentage-point increase in the unemployment rate and a 40% decline in commercial real estate prices. Banks’ performance in the test determines the size of their “stress capital buffer,” an additional capital cushion mandated by the Fed to endure hypothetical economic downturns on top of the minimum regulatory requirements.

The Bank Policy Institute expects banks to experience slightly higher hypothetical losses this year, resulting in a 3.2% decrease in average capital levels, up slightly from 3% in 2022. This, combined with forthcoming capital increases and economic uncertainty, is likely to lead banks to adopt a more conservative approach to shareholder payouts. Last year’s stress test was relatively straightforward due to the absence of a Vice Chair for Supervision at the Fed, but this year’s tests are being overseen by Michael Barr, who aims to introduce multiple scenarios to make the tests more dynamic and relevant in an ever-changing risk environment.

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