The ability of US banks to overcome the recession comes to the fore as fears of a recession grow

The ability of US banks to overcome the recession comes to the fore as fears of a recession grow

The ability of the largest US banks to withstand a severe economic downturn will be in the spotlight this week as the Federal Reserve publishes the results of the industry’s annual stress tests, amid growing fears of a recession.

The test, which goes through a series of disaster scenarios for 34 banks, including Goldman Sachs and JPMorgan Chase, is a critical gauge of financial strength and helps identify lenders’ capital available for dividends or stock repurchases.

“It always aims to capture the stress test. What is different and new is what it is now [a downturn] “We feel it may be on us,” said Oppenheimer & Co banking analyst Chris Kotowski.

Subsidiaries of foreign banks in the US with significant US investment banking activities are also subject to the Fed stress test. Industry observers are paying close attention to Credit Suisse, which was included in a watch list of institutions requiring stricter supervision by the British financial regulator, the FT reported this month.

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Test results in the US, a requirement of post-crisis Dodd-Frank financial regulations, are expected on June 23.

To pass, banks must show that they have levels of capital above government minimums following hypothetical scenarios outlined by the Fed in February, such as a nearly 40% drop in commercial real estate prices and an unemployment rate of 10 percent. and increased stress. in the corporate debt market.

The exercise will determine the so-called contingency capital stock for the largest US banks – the amount of high-quality Tier 1 equity, or CET1, that they must maintain in relation to their weighted assets that exceed the regulatory minimum. . This CET1 indicator is a critical benchmark for financial stability.

Banks, which usually aim to maintain a capital stock above the amount set by regulators, can publicly confirm the stress capital stock and disclose their shareholder return plans on June 26, two days after the results.

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“I think this stress test has the potential to prove that the industry is in a good position to handle a very catastrophic scenario, something much worse than anyone predicts,” said Jason Goldberg, a Barclays banking analyst.

If banks exceed their capital requirements, they are free from Fed restrictions on how much of their capital they can spend on shareholder dividends and share redemptions.

Unlike last year ‘s endurance tests, which acted as catalysts for higher dividends and large share repurchase programs, analysts expect banks to be more cautious about returning funds to shareholders due to uncertain financial conditions. Last year, loan losses during the coronavirus pandemic were also much lower than banks expected, allowing them to return more funds to shareholders.

Analysts expect dividends to rise this year, but predict that the rate of repurchase of shares in major banks will slow.

“If nothing else, with financial uncertainty you probably want to start raising capital,” Jeff Harte told Piper Sandler.

Jefferies analysts predict that of the six largest U.S. banks by assets – JPMorgan, Bank of America, Citigroup, Wells Fargo, Goldman and Morgan Stanley – all but Morgan Stanley will increase or maintain their current CET1 ratios by end of 2023, according to Jefferies. calculates.

Banking shares have fallen slightly more than the wider market so far this year, as worries about the recession have made investors more pessimistic about the prospects for bank profits.

However, Capital One executives Huntington Bancshares and Fifth Third Bancorp set an optimistic tone at an industry conference last week. With unemployment low and consumers having higher bank deposits than before the Covid-19 pandemic, credit quality remained strong and consumer loan losses were low, they said.

James Gorman, chief executive of Morgan Stanley, which Barclays estimates will buy about $ 7.5 billion of its own stock within 12 months of the stress test results, last week described the buying opportunity in the current share price as a “gift from heaven”. .

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