In wake of stress tests, Fed keeps restrictions on distributions, share repurchases; no changes to capital requirements

Large banks saw their losses rise to more than $600 billion under conditions simulated under a second stress test conducted by the Federal Reserve – but the banks’ capital ratios, despite the losses, would continue to be well above the minimum required, the central bank said Friday.

Nevertheless, the Fed plans to keep restrictions on banks’ distributions to investors and share repurchases, and won’t make changes to capital requirements.

In releasing the results of its second round of stress tests for the year – which the Fed imposed on the banks to gauge the longer-term financial impact of the coronavirus crisis on large banks – found that capital ratios at the banks would fall from an average starting point of 12.2% to 9.6% in the more severe scenario laid out under the second stress test. (The first round of tests was conducted in the early portion of the year, before the pandemic’s financial impact became generally apparent).

The Fed noted that the 9.6% average capital ratio starting point was “well above the 4.5 percent minimum” and that “all firms’ risk-based capital ratios would remain above the required minimum.” 

This second stress test round included two hypothetical scenarios with severe global recessions, the Fed said. The first scenario featured an unemployment rate that spiked to 12.5% and then declined to about 7.5%, while the second scenario included a peak unemployment rate of 11% followed by a more modest decline to 9 percent.

The results – even though they found that banks’ capital would erode, but not fall so far as to be close to the minimums – convinced the Fed to extend current restrictions on distributions, with modifications. “For the first quarter of 2021, both dividends and share repurchases will be limited to an amount based on income over the past year. If a firm does not earn income, it will not be able to pay a dividend or make repurchases,” the Fed said.

The Fed added that the banking firms’ capital requirements will not be reset at this time. “With the current capital requirements and distribution restrictions in place, banks have built capital over the past year,” the Fed said. “The modified restriction will continue to preserve capital and ensure that large banks can still lend to households and businesses.”

Federal Reserve Board releases second round of bank stress test results