The U.S. Federal Reserve will disclose the results of its annual bank health checks on June 23. Under the “stress test” designed following the 2007-2009 financial crisis, the Fed analyzes banks’ balance sheets against a hypothetical severe economic slowdown, the components which change annually.
The results decide how much capital banks require to be healthy and how much they can pay back to shareholders via dividends and share buybacks.
How well a bank performs determines the size of its “stress capital buffer” – an extra cushion of capital the Fed needs to survive the hypothetical slowdown, as well as regulatory minimums needed to support daily operation. The greater losses under the test, the larger the cushion.
Here are the highlights of this year’s tests:
The Fed is expected to disclose the results after market close on Thursday. Instead of passing or failing lenders, it normally announces each bank’s capital ratios and total losses under the test, with details on how their individual portfolios – like credit cards or mortgages – did.
Banks are not authorized, however, to declare their plans for buybacks and dividends until the next Monday, June 27.
The country’s major lenders, particularly JPMorgan Chase & Co (JPM.N), Goldman Sachs Group Inc (GS.N), Morgan Stanley (MS.N), Citigroup Inc (C.N), Bank of America Corp. (BAC.N), and Wells Fargo & Co (WFC.N) are closely monitored.
A TOUGHER TEST?
The Fed alters the scenarios every year. They take months to develop, which means they risk becoming obsolete. In 2020, for instance, the real economic crunch prompted by the COVID-19 pandemic was by many measures more extreme than the Fed’s scenario that year.
Notably, the Fed developed 2022’s scenario ahead of Russia’s invasion of Ukraine and the present hyper-inflationary outlook. Still, this year’s test is seen to be tougher than 2021’s because the actual economic baseline is healthier. That means a jump in unemployment and a slump in the size of the economy under the test are felt more severely.
For instance, last year’s stress test predicted a 4% spike in unemployment under a severely adverse” scenario. This year, that rise is 5.75%, caused mainly by increasing unemployment over the past year.
As a result, analysts forecast banks will be told to reserve slightly more capital than last year to account for anticipated growth in modeled losses.Buy Bitcoin Now
STRESSES IN COMMERCIAL REAL ESTATE, CORPORATE DEBT
In 2022, the test will also include “heightened stress” in commercial real estate, which was crushed by the pandemic as employees were sent home, and corporate debt markets. Global watchdogs, including the International Monetary Fund, have cautioned of elevated levels of risky corporate debt as interest rates increase globally.
ALL BANKS TESTED
This year, all 34 U.S. banks tracked by the Fed with over $100 billion in assets will go through the stress test, in comparison to 23 lenders in 2021.
That’s because the Fed agreed to a new standard in 2020 that demanded that banks with less than $250 billion in assets only have to be tested every other year. That means that big regional banks, like Fifth Third Bancorp (FITB.O) and Ally Financial Inc (ALLY.N) are up again after a year off.