All 23 US banks that participated in a new Federal Reserve stress test (Full PDF )would be able to withstand a severe global recession, demonstrating the strength of the biggest financial institutions at a time when the banking industry still is on uncertain ground.
1. One of the toughest tests ever.
According to the news previously revealed by the Federal Reserve, this year's stress test scenarios include unemployment rising to a peak of 10%, commercial real estate prices plummeting 40%, house prices falling 38%, and short-term interest rates falling to almost zero. Therefore, this test is considered One of the toughest tests ever.
Source: federalreserve.gov
Special notes, the test list of banks subject to the Fed's stress tests has come under scrutiny following the collapse of $SVB Financial Group(SIVBQ)$ . Under current rules, $SVB Financial Group(SIVBQ)$ 's first official stress test won't take place until 2024. The current rules came into effect in 2019, when legislation loosened regulations for mid-sized banks.
However, market analysts said that even if $SVB Financial Group(SIVBQ)$ accepted the Fed's stress test, the bank may pass because the test did not include the kind of sharp rise in interest rates that led to the bank's collapse.
2. How are the major banks doing in the test?
Results released by the Fed Wednesday show that these banks would have enough capital on hand to absorb losses and continue lending even if unemployment were to hit 10% and the stock market were to plunge 45%.
Their projected losses would amount to $541 billion under that hypothetical scenario.
The biggest of the group — $JPMorgan Chase(JPM)$ , $Bank of America(BAC)$ , $Citigroup(C)$ , $Wells Fargo(WFC)$ , $Goldman Sachs(GS)$ , and $Morgan Stanley(MS)$ — all would have capital buffers well in excess of the Fed’s 4.5% minimum requirement under this extreme scenario.
The same goes for the mid-sized regional banks that were a part of this test, including $PNC Financial Services Group Inc(PNC)$ , $Truist Financial Corp(TFC)$ , and $M&T Bank(MTB)$ .
Source: federalreserve.gov
In detail, of the 23 banks tested, $Deutsche Bank AG(DB)$ 's US operations suffered the most capital hit, followed by $UBS Group AG(UBS)$ Americas.
Among local banking institutions, $Goldman Sachs(GS)$ saw the biggest drop in capital levels, followed by $Morgan Stanley(MS)$ . Both banks are more focused than their peers on trading, which the Fed classifies as a riskier business.
All of the banks tested, including Bank of America, Citigroup, State Street and Wells Fargo, will meet minimum capital requirements despite an expected loss of $541 billion. Of this, $424 billion came from loan losses and $94 billion came from trading business and counterparty losses.
The results also showed that the 8 largest U.S. banks would lose nearly $80 billion in a scenario of continued high inflation and high interest rates, which is also expected for the U.S. economic outlook.
3. What does this results mean to market?
The stress test results will help determine each bank's so-called stress test capital buffer. This refers to the Common Equity Tier 1 capital (CET1) that banks must hold as a percentage of their risk-weighted assets in addition to the regulatory minimum requirements. The stress capital buffer is a combination of the maximum loss of CET1 capital during the stress test period and the bank's plan to return capital to shareholders via dividends over the next 12 months.
From Friday, banks under the test will be able to publicly confirm the amount of their indicative stressed capital buffers, when potential buyback or dividend plans may also be announced.
“Certainly the stress tests yesterday were another good sign that even if the economy softens, banks are much more resilient than what we saw back in the 2008 period,” said Edward Jones senior investment strategist Mona Mahajan.
After Fed’s results release, U.S. bank stocks mostly rose after the results were announced. $Bank of America(BAC)$ , $Wells Fargo(WFC)$ , $JPMorgan Chase(JPM)$ , $Goldman Sachs(GS)$ and $Morgan Stanley(MS)$ all rose more than 1% in after-hours trading, while $Citigroup(C)$ fell 0.3%.
$DJIA(.DJI)$ , $S&P 500(.SPX)$ gain with bank rally countering rate worries, while strong economic data stoked expectations of further interest rate hikes from the central bank.
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