In its annual stress test, the Federal Reserve reported that all 23 major U.S. banks successfully withstood a severe recession scenario, demonstrating their resilience and ability to lend to individuals and businesses. Despite predicting substantial losses, these banks maintained minimum capital levels, paving the way for potential shareholder returns.
The Federal Reserve's stress test is a crucial evaluation that determines the banking industry's capacity to return capital to shareholders through dividends and buybacks. This year's examination subjected banks to a hypothetical severe global recession, with key economic indicators such as unemployment, commercial real estate values, and home prices experiencing significant declines. The results are reassuring, given the failures of several mid-sized banks earlier this year.
Despite predicting a staggering $541 billion in losses, banks managed to sustain minimum capital requirements. Approximately 78% of the projected losses stemmed from loan losses, while the remaining losses were attributed to Wall Street trading. Credit cards emerged as the most vulnerable loan product, with an average loss rate of 17.4%.
Goldman Sachs experienced a notable decline in its portfolio, losing roughly 25% in the hypothetical recession, which prompted CEO David Solomon to reassess the bank's retail banking strategy. Commercial real estate and credit-card loan-heavy banks were particularly affected, suffering larger capital reductions.
While the stress test primarily focuses on major banks, it raises concerns about regional banks. Institutions such as U.S. Bank, Truist, Citizens, M&T, and Capital One demonstrated lower capital levels during the exam, indicating potential vulnerability. The possibility of increased regional bank regulations and stronger international standards following previous bank failures necessitates further attention.
Additionally, analysts, including Jefferies' Ken Usdin, suggest that Capital One, Citigroup, Citizens, and Truist might require additional capital buffers. As banks finalize their buyback and dividend plans, they are expected to adopt a cautious approach due to regulatory uncertainty and the looming possibility of an impending recession.
Although large banks outperformed their regional and card-focused competitors, the examination's findings should serve as a reminder to be watchful and adaptable in a financial environment that is constantly changing.