Nation’s largest banks all pass Fed’s ‘stress tests’

The largest U.S. financial institutions have enough armour to withstand the turmoil of a major and prolonged national and global recession, the Federal Reserve said. Banks that participated previous year also passed, but their capital levels have largely improved since then. The bad debts are reducing gradually.

Bank of America is under pressure to meet Fed requirements because it has stumbled in the test in three of the past five years.

The 33 banks met or exceeded regulators’ required capital cushions they would need to offset losses, according to the Federal Reserve, which on Thursday released the first portion of its annual stress test results.

While the banks registered “substantial losses” in hypothetical scenarios of both severe and extremely severe economic downturns, the Fed said that in the aggregate the 33 had stronger balance sheets and better credit quality than a year ago.

“DFAST is sort of like a dress rehearsal for the CCAR”, said Ernie Patrikis, a partner at the White & Case law firm and a former bank regulatory official at the Federal Reserve Bank of NY.

Other central banks have attempted negative interest rates, including the European Central Bank and Bank of Japan, to stimulate economic growth.

Under the Fed’s most extreme scenario in this year’s test, the U.S. economy falls into a deep recession causing the stock market to plunge by 50 per cent. Unemployment climbs above 10 per cent, and housing prices drop by 25 per cent and commercial real estate prices fall by 30 per cent. Investors, in this scenario, would be so panicked that yields on short-term U.S. Treasuries would go negative – meaning even the safest of assets would still lose money.

A year ago the capital plans of Deutsche Bank and Santander were rejected, while that of Bank of America earned a conditional pass. Bank of America was given several months to address the problems the Fed saw.

However, the results released on Thursday – part of a test known as “DFAST” – only offer a glance of big banks’ capital pictures under stress.

The tests, instituted in the wake of the devastating financial crisis of 2008, were based on the banks’ actual fourth-quarter 2015 capital and loan strength.

While the Fed does not issue passing or failing grades, poor performance on the closely watched exams could be embarrassing for a bank. That test evaluates banks’ individually tailored plans for surviving a crisis.

Shareholders should tune in next Wednesday to learn whether Bank of America will be permitted by the Fed to increase its dividend and/or its share-buyback program, which is determined in the comprehensive capital analysis and review process.

Analyst Steven Chubak of Nomura Securities said, “For the big banks, the results were just incredibly robust”.

Of the 33 banks that took part in DFAST, Huntington Bancshares Inc produced the lowest minimum Tier 1 common equity ratio, of 5 percent, under a severely adverse scenario. Morgan Stanley and BMO Financial Corp produced the weakest Tier 1 leverage ratio – another measure of capital strength relative to assets – of 4.9 percent, under that scenario. Banks had an April deadline to submit those plans to the regulator. The dollar rose by more than 3 percent at one stage, the most in a day since 1978. “It could mean no rate hikes this year”, Gagnon said. The Fed generally assumes that banks would not be able to pass along negative rates to consumers by charging them for holding their deposits.