The nation's biggest banks have enough capital to withstand a substantial economic downturn, according to the Federal Reserve's
All 31 banks examined this year were able to withstand the test's
The banks with the biggest declines in common equity tier 1, or CET1, capital were Deutsche Bank USA at 13.3% — coming down from a pre-stress ratio of 27.8% — and UBS Americas, which fell by 9.3% but still maintained a post-stress minimum of 10%. The banks that posted the lowest overall post-stress minimum CET1 capital ratios were BMO at 5%,
Even so, the results represent the biggest capital declines in six years, with the banks' aggregate CET1 ratio dropping by 2.8% versus 2.5%
Balance sheet blitz
Fed Vice Chair for Supervision Michael Barr attributed the greater projected losses to changes in the riskiness of banks' balance sheets and higher expenses. Writing in a statement issued alongside the results, Barr noted that the scenario in this year's test was little changed from last year's.
"While banks are well-positioned to withstand the specific hypothetical recession we tested them against, the stress test also confirmed that there are some areas to watch," Barr said. "The financial system and its risks are always evolving, and we learned in the Great Recession the cost of failing to acknowledge shifting risks."
The Fed attributed the uptick in projected losses to three primary risks:
The report noted that banks have increased their credit card balances by roughly $100 billion during the past year, pushing the total volume to roughly $1 trillion. This trend comes as credit card delinquencies have been rising steadily since 2021, roughly doubling over that period to 3.5%. Under the stress scenario, those delinquencies increased substantially, resulting in $175 billion of theoretical losses.
Ally was projected to see the greatest losses from its credit card book, which was projected to decline 40%. Goldman Sachs (25.4%), Capital One (23.2%), TD Group (21.5%) and Discover (20.3%) also saw significant credit card losses in the stress test. BMO's leading loss category was also credit cards, at 18%.
On the corporate lending side, the Fed noted that banks have largely shifted their books toward non-investment grade corporate debt, though it notes that this shift largely corresponds with banks electing to downgrade their holdings based on changing conditions with their borrowers and broader economic conditions. Commercial and industrial loan losses were projected to total $142 billion for the banks.
The Fed also noted that banks have seen their fee incomes dwindle in recent years while expenses have increased, resulting in lower net income. While both fees income and expenses would decline under the scenario, expenses would continue to outpace non-interest income.
The results also showed sustained losses to commercial real estate loan books, accounting for roughly $77 billion of losses, or 11% of the total projected decline. But it noted that this risk exposure is on par with what was measured by last year's test.
As a result of this year's stress test, the aggregate stress capital buffer applied to the large banks will likely increase modestly because capital declines in this year's test exceeded last year's results.
Later this week, the Federal Reserve will release the results of its annual check-up on larger banks' balance sheets. Experts say there are always surprises, but that pending capital rules may have a bigger impact than the stress-test results on banks' dividend and buyback decisions.
Individual banks are free to announce how they will factor this change into their capital plans for next year as soon as Friday, though the Fed will not announce bank-by-bank buffers until later in the summer. Banks are afforded a window in which they can raise issues with their stress test results and provide more accurate data, which could result in slight changes to their overall buffers.
Banks push back
Even before the results were released, banking interests in Washington
Francisco Covas, BPI's head of research, and Sean Campbell, FSF's chief economist, testified in front of the House Financial Services Committee's Subcommittee on Financial Institutions and Monetary Policy during a hearing on stress testing. They argued that the Fed must be more transparent, particularly with respect to its stress scenarios, not only to create better scenarios, but to meet their statutory requirements under the Administrative Procedure Act.
"Regulatory transparency ensures that the public can understand how their public institutions operate in the light of day and allows the public to assess the impact of regulation on affected entities and the broader economy," Campbell said. "Banking regulations that are opaque frustrate prudent risk management and create costly regulatory uncertainty that has deleterious effects on the whole economy."
Both groups also reiterated their yearslong complaint that despite having sufficient capital to withstand the tested scenarios — as well as real-world hardships such as the COVID-19 pandemic — banks have continued to see their stress capital buffers increase year after year as a result of steadily more rigorous stress tests. They argue that having to constantly increase capital in this manner is disruptive to banks' business models.
"Although some volatility in the SCB is necessary and expected as the scenarios change each year to reflect evolving economic conditions, emerging risks and changes to bank portfolios, the current level of volatility appears excessive and disconnected from actual changes in banks' risk profiles," Covas said. "This unpredictability makes it challenging for banks to effectively plan and manage their capital requirements, since there is only one quarter between receiving the stress-test results and the new requirement becoming effective."
Exploratory scenarios
This year's stress test also included exploratory scenarios that tested the ability of all 31 banks to withstand funding challenges. The largest and most complex banks were also tested for their ability to weather severe shocks to their trading books.
Under two funding tests, banks saw their capital levels decline by 2.7% and 1.1%, respectively. The banks that went through the market shocks saw estimated book losses of $70 billion and $85 billion apiece in the two scenarios.
The new components will have no bearing on banks' capital requirements for next year.
"The stress test is one of the key innovations to address those dynamic risks, and the results of this year's test demonstrate that the dynamism built into the stress test works as designed by picking up some increasing risks on bank books," Barr said in his statement. "The banking system is well positioned to deal with those risks. The exploratory scenarios also enable us to keep the stress test vibrant by continuing to explore new areas of risk."
