Stress tests results spur share repurchases prohibition, dividend payments cap at big banks for Q3

The 34 banks that participated in this year’s stress tests, based on results of a separate sensitivity analysis conducted in light of the coronavirus pandemic, will be required to preserve capital by suspending share repurchases and capping dividend payments for the third quarter, the Federal Reserve said Thursday.

The central bank said that third-quarter dividend payments may not exceed second-quarter dividends and will be permitted only if a bank has earned sufficient income. “The restrictions will apply for the third quarter of 2020 and may be extended by the Board quarter-by-quarter, as the economic situation continues to evolve,” the Fed said in its report on the analysis.

The Fed said it’s also requiring each of the banks to resubmit and update its capital plan later this year to reflect current stresses.

The decision to permit dividend payments was made by board vote June 18 and was not unamimous. “I do not support giving the green light for large banks to deplete capital, which raises the risk they will need to tighten credit or rebuild capital during the recovery. This policy fails to learn a key lesson of the financial crisis, and I cannot support it,” said Fed Gov. Lael Brainard, who voted against the move, in a statement.

Fed Vice Chair for Supervision Randal Quarles said this year’s testing and analysis show that the big banks are continuing to serve as a source of strength to the economy. The board’s approach to dividends, he said in a statement, “builds on our existing standards on capital distributions, which restrict distributions based on recent income.” He added that if circumstances warrant, “we will not hesitate to take additional policy actions to support the U.S. economy and banking system.”

The Fed noted that in this year’s regular stress tests, all large banks remained “strongly” capitalized. Results were more mixed in the sensitivity analysis, performed to explore the vulnerabilities of banks to the downside risks to the economy posed by the coronavirus outbreak and response, or what the Fed terms the “COVID event.”

The sensitivity analysis assessed the resiliency of large banks under three hypothetical recessions, or downside scenarios, which could result from the coronavirus event. The scenarios included a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession.

In the three downside scenarios, the unemployment rate peaked at between 15.6% and 19.5%, which is significantly more stringent than any of the Fed’s pre-coronavirus stress test scenarios (which, the Fed emphasized, are not predictions or forecasts of the likely path of the economy or financial markets).

In aggregate, loan losses for the 34 banks ranged from $560 billion to $700 billion in the sensitivity analysis, and aggregate capital ratios declined from 12% in the fourth quarter of 2019 to between 9.5% and 7.7% under the hypothetical downside scenarios.

The Fed noted that under the U- and W-shaped scenarios, most firms remain well capitalized, but several would approach minimum capital levels. (This analysis didn’t address potential effects of government stimulus payments and expanded unemployment insurance, it noted.)

In the regular stress tests – designed prior to the coronavirus – results were comparable to the V-shaped downside scenario in the sensitivity analysis, in aggregate, and show that all large banks remain strongly capitalized, the Fed noted. “The Board will use the results of this test to set the new stress capital buffer requirement for these firms, which will take effect, as planned, in the fourth quarter,” it said.

The Fed said it will not object to five foreign banks whose capital planning practices were evaluated as part of the stress tests.

Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Results

Assessment of Bank Capital during the Recent Coronavirus Event

Statement by Vice Chair for Supervision Quarles

Statement by Governor Brainard