Big Banks Ace first round of Federal Reserve's Stress Test

WASHINGTON – US largest banks have enough reserves to continue lending in a serious economic downturn, a sign that business is decades in economic expansion, better in annual "stress tests" despite increasingly serious hypothetical scenarios . [19659002] The Federal Reserve said on Friday that 18 of the largest banks could be an extreme market shock, including double-digit unemployment, and a 50% US stock market decline – and still have enough capital to continue operating.

The positive scorecard signals the banks Including JPMorgan Chase & Co., Bank of America Corp.,

Citigroup
Inc.

and Goldman Sachs Group Inc. – will probably get a green light to increase dividends and buy back shares when the second round of test results is released next week.

"The results confirm that our financial system remains resilient" Fed Vice Chairman Randal Quarles said in a written statement. He said the companies, representing about 70% of US bank funds, "would be well positioned to support the economy even after a major shock."

While the banks faced one of the toughest stress test scenarios yet, the exercise has become easier due to a recent Fed revision of the tests, including a reduced threat of public detection of poorly performing banks.

"The stress tests are still a meaningful limitation on capital allocation," says CEO Arthur Angulo. at the Promontory Financial Group and a former Fed official. "It has become less burdensome, and it is certainly less of a public play than it was in years past."

Under Fed's "grave unfavorable scenario", the big banks would together lose $ 41[ads1]0 billion – an improvement from $ 464 billion Total losses expected in last year's worst-case hypothetical scenario for the same companies. The equity capital ratio, which measures high-value capital as a percentage of assets, will fall to 9.2%, from an actual level of 12.3% at the end of last year.

Tests were implemented after the financial crisis in 2008 to ensure banks have enough reserves to ward off government bailouts even in a severe recession. The banks have since increased their capital buffers, and they have performed ever better results in the stress tests in recent years.

Banks said the results showed that the industry was healthy and deserved a more consistent and transparent stress test regime.

"The US banking system is extremely well capitalized," said Francisco Covas, head of research at a trade group called the Bank Policy Institute, in a press release. The uncertain outcome of the stress tests "leads to excessive volatility in banks 'capital requirements over time, impeding banks' ability to further support economic growth," he added.

The Fed runs two rounds of tests each year. The first determines how each bank's portfolio will go under the scenarios of a "quantitative" or number-based review. Next Thursday, it will release a second round that takes into account how much each bank wants to spend in dividends and shareholders, as well as "qualitative" factors such as the accuracy of the bank's internal data and the board.

Seventeen banks with assets generally between $ 100 billion and $ 250 billion were allowed to skip the stress tests this year as they transition to a new two-year plan.

Under the new rules, most banks next week will no longer meet the opportunity to fail The subjective part of the test.

If they perform poorly during that part of the test, banks may still be penalized by the Fed through a future enforcement or other penalty. Five US units of foreign banks are still on the hook to fail in that part of the test because they are newer to the process.

Banks may still face a public charge during the next week's number-based part of the test, which assesses whether their capital would fall under regulatory requirements under the stress scenario. This has rarely happened because the Fed allows banks to reduce shareholder payments and submit their capital plans if they fail. The last company that failed the quantitative part of the test was

Zions Bancorp
.

in 2014.

The Fed has also helped banks to stave off a failing class even when they failed to clear capital requirements during the date of death.

Last year were the main levels of Goldman Sachs Group, Inc. and

Morgan Stanley

fell below regulatory minimum during the most severe scenario. While both were not allowed to increase payouts, banks received a "contingent non-objection" rating instead of drastically cutting payments or failing.

The Fed has suggested eliminating the threat of error entirely in the quantitative part of the test. In a proposal from last year, the test results will instead be integrated into a continuous capital requirement for large banks.

Write to Lalita Clozel at lalita.clozel. @ Wsj.com