Fed Says Banks Can Weather Severe Downturn as Stress Tests Become Latest Political Football

Federal Reserve Vice Chair for Supervision Michelle Bowman, left, and Chair Jerome Powell. The central bank’s stress test covered 22 lenders this year. (AFP via Getty Images)

The largest U.S. lenders are well-positioned to withstand a severe economic downturn, the Federal Reserve’s annual stress test results showed Friday, an outcome that suggests banks will announce plans to distribute more capital to shareholders in the coming days.

The results were the first under Fed Governor Michelle Bowman’s tenure as the Fed’s top Wall Street regulator. The stress test is the subject of an ongoing fight between financial regulators and bank lobbies, and Bowman nodded to her own criticisms of the test in a statement Friday.

The 22 big banks subject to the test’s hypothetical recession scenario, including JPMorgan Chase, Goldman Sachs, and Wells Fargo, would have enough capital to absorb more than $550 billion in losses and still have the ability to lend to consumers and businesses.

JPMorgan stock has advanced 0.9% in premarket trading on Monday, while Goldman Sachs has climbed 3%, Wells Fargo has risen 2.1%, Citigroup has ticked up 0.8%, Bank of America has advanced 1.4%, and Morgan Stanley has gained 0.9%.

The Fed noted that their hypothetical conditions set forth this year—which included steep declines in real estate prices and unemployment rising to 10%—were generally less strenuous than last year’s.

“Large banks remain well capitalized and resilient to a range of severe outcomes,” Bowman, who was confirmed as the Fed’s vice chair for supervision earlier this month, said in a statement.

Investors and analysts are closely monitoring the Fed’s report for both a window into systemically important banks’ health and for data to calculate how banks may choose to return capital to shareholders.

This year, however, investors are paying more attention to clues about how the tests themselves may change under the Trump administration.

Regulators appointed by President Donald Trump are moving to pull back bank regulations, including those governing stress tests and various capital requirements, a shift that bank lobbyists have fought for in recent years. That effort is being met by criticism from Democrats.

Bowman, who was nominated by Trump and whose views on regulation tend to line up with banks’ preferences, said of the results in a statement, “One way to address the excessive volatility in the stress test results and corresponding capital requirements is for the Board to finalize the proposal that would average two consecutive years of stress test results, which was released in April.”

The annual tests, established by the Dodd-Frank Act of 2010, directly affect the level of capital banks must hold—and how much room they have to increase payouts to shareholders.

Under the most severe scenario modeled by the Fed this year, the key measure of financial resilience known as the common equity Tier 1 capital ratio would fall 1.8 percentage points. The ratio refers to a bank’s core capital relative to its risk-weighted assets.

After years of arguing that the Fed’s tests are too opaque, too onerous, and too volatile from year to year, Wall Street is welcoming proposed changes from Trump-appointed regulators. They want to lighten the capital that banks have to hold, provide banks with more insight into the tests, and give banks more flexibility in how they run their businesses.

Those goals have set off alarm bells for consumer protection advocates and Democratic lawmakers who warn that lower capital requirements endanger the financial system. Better Markets, a nonprofit group that supports stronger bank regulation, has opposed the Fed’s recent proposal that would make the test easier for banks to navigate.

“As everyone knows, if you provide the answers to a test before it is taken, the test is worthless, but the Fed is nonetheless going to do this,” said Dennis Kelleher, chief executive of Better Markets, in a statement on Friday. “This will give the industry the ability to game the tests and guarantee they will pass with flying colors.”

Write to Rebecca Ungarino at rebecca.ungarino@barrons.com