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All 31 largest US banks have passed the Federal Reserve’s annual stress tests, convincing regulators that they can withstand a theoretical scenario in which unemployment rises to 10 percent during a severe recession.
The Fed said on Wednesday that under its base case scenario, banks such as JPMorgan Chase, Goldman Sachs and Bank of America would lose nearly $685 billion, the largest capital loss in six years, but would still meet minimum regulatory standards.
The scenario included a 40 percent decline in commercial property prices, a significant increase in office vacancies and a 36 percent decline in house prices.
“This year’s stress test shows that large banks have sufficient capital to withstand a highly stressful scenario and meet their minimum capital ratios,” said Michael Barr, the Fed’s vice chairman for banking supervision.
“The aim of our test is to help ensure that banks have sufficient capital to absorb losses in a highly stressful scenario,” he added.
The tests calculate the minimum amount of capital that banks must hold in relation to their assets to absorb losses.
The banks, which often use the results of the test to inform their investors about possible distributions to their shareholders, will provide an update on their expected new capital requirements on Friday afternoon.
Jason Goldberg, a research analyst at Barclays, estimates that the capital needs of several large banks, including Goldman and BofA, will increase more than analysts expected, potentially leaving less capital for potential dividends and buybacks.
Goldman shares lost 1.7 percent in after-hours trading, while BofA shares fell 0.3 percent.
The annual exam was launched after the 2008 financial crisis and was seen as an important factor in restoring confidence in the banking sector. In recent years, the country’s largest banks have generally passed the tests, usually by a wide margin, raising questions about their usefulness and purpose.
Matthew Bisanz, a financial services partner at law firm Mayer Brown, said the tests’ reliance on capital buffers “focuses people on the wrong things.”
“Last March [2023]we saw three banks destroyed in one month,” he said, referring to the bankruptcies of Silicon Valley Bank, First Republic Bank and Signature Bank. “Yet all 31 of these banks survive a stress event that lasts nine quarters. That underscores how unrealistic the stress test is.”
The results come at a time when the capitalization of large U.S. banks is once again in focus and regulators are considering changes to their proposal to implement the so-called Basel III endgame capital rules.
The Fed’s original proposal, which called for a significant increase in capital requirements, sparked aggressive lobbying by major U.S. banks. Fed Chairman Jay Powell has since said the proposed new rules would likely be significantly changed.
This year’s stress tests would reduce banks’ core capital ratio, their most important buffer against losses, by 2.8 percentage points. That would be the biggest drop since 2018.
The Fed said the higher losses were partly the result of expectations of higher losses on credit card loans at the nation’s largest banks, which rose nearly 20 percent from a year ago. Banks’ corporate loan books also became riskier as lenders had less buffer to absorb a big blow due to higher costs and lower fees.
Another scenario, examining what would happen if five large hedge funds failed, found that the largest and most complex banks were actually significantly at risk, and were expected to lose between $13 billion and $22 billion in total.
Additional reporting by Stephen Gandel in New York