After Fed’s Risk Assessments, U.S. Banks Predicts Receiving a Clear Report

U.S. banks expect a clean bill
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Large US banks are hopeful that the Federal Reserve will give them a clean bill of health this week, allowing them to distribute billions of dollars in excess capital to investors.

The results of the central bank’s annual bank “stress tests,” which assess how much capital banks would need to withstand a severe economic downturn, will be released on Thursday.

The annual exercise, which was implemented in the aftermath of the 2007-2009 financial crisis, is critical to banks’ capital planning because it dictates how much cash they can return to shareholders in the form of dividends and share buybacks.

Analysts and executives believe lenders will be well-prepared for the 2022 exam as the economic stresses of the COVID-19 pandemic subside and lenders become more adept at navigating the exam.

“All should pass,” Barclays analysts wrote in a note on Thursday. “We also anticipate that almost every bank involved will increase its dividend this year and next.”

Banks have performed well in recent tests, which included supplemental exams implemented in the midst of the pandemic-induced economic turmoil. Last year, the Fed estimated that banks would lose $474 billion in a severe downturn, but that they would still have more than twice the capital required under Fed rules.

Nonetheless, analysts anticipate that this year’s test will be more difficult than the one in 2021, and that bank buffers will be slightly higher as a result.

This is because the test becomes more difficult as the real economy strengthens, while banks have also reduced the buffers they had set aside for pandemic losses that did not materialize. The Fed’s “severely adverse” scenario for this year predicts an increase in the unemployment rate of 5.75 percentage points, compared to 4 percentage points in 2021.

The size of a bank’s “stress capital buffer” – an extra cushion of capital required by the Fed for banks to weather a hypothetical economic downturn on top of regulatory minimums required to support daily business – is determined by how well it performs.

The larger the buffer, the greater the test losses.

Credit Suisse analysts predict that the buffer will be 3.3 percent on average, up from 3.2 percent last year.

“There may be more stress, but there should be enough extra capital to make this manageable,” they wrote.

During a Morgan Stanley (MS.N) conference in New York last week, top bank executives reacted calmly to the tests.

“Given the scenario we had to deal with, our stress capital buffer may increase. And we’re well-prepared to deal with it “Mike Santomassimo, chief financial officer of Wells Fargo & Co. (WFC.N), informed investors and analysts.

Morgan Stanley CEO James Gorman said at the same event that he would be “surprised” if the bank’s capital numbers were “significantly different.”

That calmness may not last. This year’s examination is relatively simple, in part because the Fed has been without a Vice Chair for Supervision since Randal Quarles stepped down last year.

Quarles, who was appointed by former Republican President Donald Trump, streamlined the stress test process in response to industry complaints that it was often opaque and subjective.

Many analysts anticipate that the Fed will reconsider those changes once Michael Barr, Democratic Vice President Joe Biden’s nominee to replace Quarles, is confirmed by the Senate.

Barr could reinstate a requirement that banks pre-fund nine quarters of expected dividend payments as part of their capital planning, a requirement that Quarles had reduced to four quarters.

He could also reverse steps taken by Quarles to make the tests more predictable, such as providing more information about the Fed’s models and eliminating the central bank’s ability to fail lenders based on subjective concerns, such as risk management lapses.

“We expect Biden’s Fed picks to work next year to toughen” the test, wrote Cowen Washington Research Group analyst Jaret Seiberg.

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