By Pete Schroeder
WASHINGTON (Reuters) – Major U.S. lenders are expected to show they have enough capital to weather any further turmoil in the banking sector during this week’s Federal Reserve health checks, although payments to investors who resultant earnings are expected to fall slightly, analysts said.
The central bank will release the results of its banking “stress tests” on Wednesday, which assess how much capital banks would need to withstand a severe economic downturn.
The annual exercise, introduced in the wake of the 2007-2009 financial crisis, is an integral part of banks’ capital planning, dictating how much money they can return to shareholders through dividends and buyouts. shares.
The 2023 tests come in the wake of this year’s banking crisis in which Silicon Valley Bank and two other lenders failed. They found themselves on the wrong side of Fed interest rate hikes, suffering large unrealized losses on their holdings of US Treasury bonds, which spooked uninsured depositors.
Wall Street lenders, including Citigroup Inc, Bank of America, JPMorgan Chase, Goldman Sachs Group, Wells Fargo and Morgan Stanley, typically attract the most attention. But with continued investor jitters about the sector, smaller lenders including Capital One, US Bancorp and Citizens will likely also be in the spotlight.
Despite the turmoil and the toughest review in years, analysts and bank executives expect all 23 lenders tested to have capital above regulatory minimums.
“The 2023 Fed stress test throws the kitchen sink on banks and allows them to show that the biggest banks can handle one of the toughest tests yet,” the analysts wrote Thursday. from Wells Fargo.
“Dividends must be safe and banks must have excess capital to return to shareholders in most circumstances, even at a slower rate than in the past.”
The industry has performed well in recent years, although the Fed has come under fire after the spring bank failures for failing to probe banks’ weaknesses in the event of a rate hike in earlier tests.
Last year, the Fed found that banks would suffer combined losses of $612 billion in the event of a severe economic downturn, but that would still leave them with about double the capital required under Fed rules.
This year’s test is even more difficult. The Fed’s “extremely adverse” scenario envisions the unemployment rate rising 6.5 percentage points from 5.8 percentage points in 2022. Indeed, the test becomes more difficult as the real economy weakens. strengthens and that the real unemployment rate in the United States is lower in 2023.
The test will also consider a 40% drop in commercial property prices, an area of greater concern this year as persistent vacancies in the pandemic era stress borrowers.
A bank’s performance dictates the size of its “stress capital buffer” – an additional capital cushion the Fed needs for banks to weather the hypothetical economic downturn, on top of the regulatory minimums required to support the daily activities. The greater the losses under the test, the larger the buffer.
The Bank Policy Institute, a Washington-based banking lobby group, said Thursday it expects banks’ hypothetical losses to be slightly higher this year. Average capital levels will fall 3.2% in 2023, up slightly from 3% in 2022, he predicted.
RBC analysts predicted earlier this month that hypothetical loan losses would be largely due to exposure to commercial real estate and that some banks would face higher reserves.
That, combined with looming further capital increases and uncertainty about the economic outlook, will make banks slightly more cautious about payments this year, analysts said.
“Capital return expectations continue to decline given the looming headwinds,” Jefferies analysts said this month.
Last year’s test was relatively straightforward, in part because the Fed hasn’t had a vice chairman for oversight since Randal Quarles resigned in 2021. This year, the tests are being overseen by his successor Michael Barr, who said he wanted to make them more dynamic. using several scenarios.
This year, for example, also includes an “exploratory market shock” for the eight largest and most complex banks. Although this does not affect capital, it will be used to assess the potential use of multiple scenarios in future stress testing exercises.
“In an ever-changing risk environment, stress tests can quickly become irrelevant if their assumptions and scenarios remain static,” Barr said in December.
(Reporting by Pete Schroeder; editing by Michelle Price and Deepa Babington)