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Michael Barr, Vice Chair for Supervision at the Federal Reserve, testifies about recent bank failures at a U.S. Senate Committee on Banking, House and Urban Affairs hearing on Capitol Hill in Washington, DC, May 18, 2023.
Saul Loeb | AFP | Getty Images
All 23 U.S. banks that participated in the Federal Reserve’s annual stress test weathered a severe recession scenario while continuing to lend to consumers and businesses, the regulator said Wednesday.
The banks were able to maintain minimum capital levels, despite $541 billion in expected losses for the group, while continuing to lend credit to the economy in the hypothetical recession, the Fed said in a press release.
Started in the aftermath of the 2008 financial crisis, which was caused in part by irresponsible banks, the Fed’s annual stress test dictates how much capital the industry can return to shareholders through buybacks and dividends. In this year’s exam, banks underwent a “severe global recession” with unemployment reaching 10%, a 40% drop in commercial property values and a 38% drop in house prices.
Banks have been at the center of heightened supervision in the weeks following the collapse of three medium-sized banks earlier this year. But smaller banks completely avoid the Fed’s test. The test examines giants, among other things JPMorgan Chase And Wells Fargointernational banks with major US operations and the largest regional players, including PNC And Truist.
As a result, overcoming the stress test hurdle is not the “all clear” signal it has been in previous years. Tighter regulations for regional banks are still expected in the coming months due to the recent bankruptcies, as well as stricter international standards that are likely to increase capital requirements for the country’s largest banks.
“Today’s results confirm that the banking system remains strong and resilient,” said Michael Barr, vice chairman of supervision at the Fed, in the press release. “At the same time, this stress test is just one way to measure that strength. We need to remain humble about how risk can arise and continue our work to ensure banks can withstand a range of economic scenarios, market shocks and other stresses.”
Goldman’s credit card losses
Loan losses made up 78% of the $541 billion in expected losses, with most of the remainder coming from trading losses at Wall Street firms, the Fed said. The percentage of total loan losses varied significantly between banks, from a low of 1.3% at CHarles Schwab up to 14.7% at Capital One.
Credit cards were easily the most problematic loan product in the exam. The average card loss rate in the group was 17.4%; the second worst average loss rate was for commercial real estate loans at 8.8%.
Among card issuers, Goldman Sachsportfolio posted a nearly 25% loss rate in the hypothetical downturn – the highest for a single loan class among the 23 banks – followed by Capital One’s 22% rate. Mounting losses in Goldman’s consumer division in recent years, driven by credit card loan commissions, forced CEO David Solomon to deviate from his retail banking strategy.
Regional banks pinched?
The group saw their total capital level fall from 12.4% to 10.1% during the hypothetical recession. But that average disguised larger capital hits — which cushion credit losses — seen in banks more exposed to commercial real estate and credit card loans.
Regional banks incl American bank, Truist, Citizens, M&T and card oriented Capital one had the lowest stressed capital levels in the exam, fluctuating between 6% and 8%. While still above current standards, those relatively low levels could be a factor if upcoming regulations force the industry to hold higher levels of capital.
Large banks generally outperformed regional and card-oriented firms, Jefferies analyst Ken Usdin wrote in a research note Wednesday. Capital One, Citigroup, Citizens and Truist could see the largest increases in required capital buffers after the exam, he wrote.
Banks are expected to announce updated plans for buybacks and dividends on Friday after the close of regular trading. Given uncertainties about upcoming regulation and the risks of an actual recession in the year ahead, analysts have said banks are likely to be relatively conservative with their capital plans.
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