Even Smooth Bank Stress Test Results Fray Nerves

By Breakingviews

The annual stress tests that banks undergo are supposed to soothe nerves. This year they’ll probably jangle them. The 31 large U.S. lenders put through their paces by the Federal Reserve sailed through, showing capital levels that remained sound even under theoretical spikes in unemployment, plunging real estate prices, and market routs. The near-$300 billion of capital they hold that’s surplus to the required amount must be burning a hole in their pockets.

This year’s test resembled last year’s, but with some tweaks. Interest rates started higher and fell faster. Stock and bond prices declined more dramatically. In total, the banks, from Ally Financial (ALLY) to Wells Fargo (WFC), emerged with $684 billion of losses, but all remained at or above their minimum required levels of capital. The test may lead to slightly tougher requirements for Goldman Sachs (GS), Wells Fargo, Bank of America (BAC) and JPMorgan (JPM), according to Jefferies analysts, and slightly lower for Citigroup (C).

One conclusion is that the $1.3 trillion of “common equity tier one” capital that the U.S. banks held at the end of March is more than enough. It’s $280 billion higher than what they officially need, based on Breakingviews calculations from quarterly filings. JPMorgan sits on around $50 billion of excess capital, two years’ worth of dividends and buybacks at its current rate, or one whole year’s worth of earnings. That cash could, in theory, be paid back to shareholders.

Or at least, it could if the goalposts weren’t about to move. The Fed is wrangling with itself, its peers, the banks, and their lobbyists over a tweak to capital rules known as Basel Endgame. After botching its initial proposal last July, the Fed is now rethinking. Clarity could take a year, but where the needle falls matters a lot. In very simplistic terms, if capital requirements increased by 25%, as the Fed said it could for some, all that excess would disappear. Acrimony is rife: JPMorgan had already critiqued the Fed’s stress test math by Thursday, saying it had actually been too generous.

It’s not that banks would pay their spare cash out in a big slug anyway. Bosses like JPMorgan’s Jamie Dimon often opt to have more than the regulators demand. Besides, banks have been buying back more this year than they did last year, though less than they did in times past. Over the coming days, lenders are likely to announce buybacks sizeable enough to whet investors’ appetites, but restrained enough to make a point about how unhelpful it is to be left in capital limbo.

Context News

The U.S. Federal Reserve on June 26 released the results of its annual stress tests of large U.S. banks, showing that all were sufficiently padded against a set of theoretical risks, including spiking unemployment and plunging real estate prices. Of the 31 banks that underwent the tests, all emerged with their common equity Tier 1 capital – a regulatory measure of capital adequacy – above the required minimum. The test showed banks would experience $684 billion of total losses. JPMorgan said on June 27 that its own calculations suggested losses that were “modestly higher”. The Fed and other regulators are considering how to modify or repropose a set of capital adequacy changes to what is known as the Basel Endgame, but are at odds over how to handle the revisions, Reuters reported on June 20. Banks and their lobbyists have vehemently opposed the new rules, originally proposed in July 2023, which would inflate the risk-weighted assets against which their required minimum capital ratios are calculated. Some executives raised the possibility of suing the regulators for overreach.

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