The Fed is cracking down on big banks to guard against risk posed to the financial system from the coronavirus pandemic
This pandemic recession marks the first time the Fed has issued such across-the-board limits on the largest banks since the aftermath of the financial crisis.
Most banks are in good shape now, the Fed’s Vice Chair Randal Quarles said in a statement. “The banking system remains well capitalized under even the harshest of these downside scenarios—which are very harsh indeed," Quarles said.
However, if there is slower U-shaped recovery or a W-shaped scenario where a brief recovery is followed by a harsh second drop later this year, “several (financial firms) would approach minimum capital levels," according to a Fed statement. The banks reviewed could incur loan losses of $560 billion to $700 billion under some scenarios, the Fed found.
The hopeful outlook was not shared by all Federal Reserve Board members. Federal Reserve Gov. Lael Brainard wrote a separate statement calling on the Fed to block dividend payouts to shareholders during the third quarter, not just limit them.
“I do not support giving the green light for large banks to deplete capital, which raises the risk they will need to tighten credit or rebuild capital during the recovery. This policy fails to learn a key lesson of the financial crisis, and I cannot support it," wrote Brainard, who was appointed by President Obama.
The Fed’s decision adds to the already-bleak reality gripping the American economy during the worst recession since the Great Depression.
More than 30 million Americans have claimed unemployment benefits as of last week, and more major companies keep filing for bankruptcy each week. Despite trillions of dollars in government stimulus and unprecedented intervention from the Fed, many say an economic recovery hinges most on more federal assistance and a vaccine or cure to end to the coronavirus pandemic.
This recession marks the first big test of banking industry reforms put in place after the financial crisis. The banking industry has emphasized that it has significantly more capital to weather a downturn and has not stopped lending to corporations or retail investors.
But some regulators have warned that after years of record profits, the banking industry could be hit hard depending on how long this downturn persists.
“If this goes on long enough, it could produce strains in the banking sector. And then the Fed and Congress and Treasury would have to step in to make sure that the banks are sound,” Neel Kashkari, the head of the Federal Reserve Bank of Minneapolis, said on “Face the Nation” in April.
The Fed typically conducts a “stress test” to assess whether the largest banks could survive a hypothetical economic crisis without needing a taxpayer bailout or being forced to stop lending. The hypothetical scenario for this year’s traditional stress was published in February, just as the coronavirus pandemic and its economic devastation began to take hold.
The Fed quickly realized that the extreme scenario it had dreamed up paled in comparison to the escalating crisis. The typical test looks at how the banks would perform, for example, if unemployment spiked to 10 percent. Now, the official unemployment rate is 13.3 percent, and the real rate is likely 3 percentage points higher.
The Fed then developed a coronavirus-specific test it used to shape its policy on payouts of shareholder dividends.
The Fed’s approach has been met with its share of criticism. For example, the traditional test typically include data specific to large banks, with a spotlight on specific banks that need work. But this new test aggregated data comparing how the banking system would fare as a whole.
Three Democratic senators said it was “highly disconcerting” that the test would not include bank-by-bank results. In a Tuesday letter to Fed Chair Jerome H. Powell and Quarles, Sens. Brian Schatz, Sherrod Brown and Elizabeth Warren said “transparency surrounding the results of the tests is a bedrock principle of the stress testing framework.”
"This decision could undermine confidence in the banking system,” the senators wrote.
The letter also raised concerns about bank capital requirements being tied to the results of the traditional stress test from earlier this year. Not basing those requirements off the coronavirus-specific sensitivity analysis, the senators wrote, could lead to “lower than appropriate” guidelines that don’t match the current reality.
Failing to disclose the individual results of each bank could also mask weaker financial institutions from needed scrutiny, said Gregg Gelzinis, a senior policy analyst for the Center for American Progress, who called the decision a “critical weakness.”
“This is going to undermine the usefulness of the results,” Gelzinis said.
Eight of the country’s biggest banks, including JPMorgan Chase and Bank of America, had already suspended buybacks earlier this year as the economy slowed down due to the coronavirus. But bank CEOs have defended their need to continue dividends.
“From our perspective, our dividend is sound, and we plan on continuing to pay it,” Citigroup CEO Michael Corbat told CNBC this week.
Among America’s biggest banks, JPMorgan Chase and Wells Fargo have paid out the most in dividends to shareholders since 2008, about $80 billion each, according to S&P Global Market Intelligence data. Bank of America and Citigroup paid out about $52 billion and $30 billion, respectively, during that period.
Wells Fargo CEO Charles Scharf said in April that dividends were important to shareholders: “If they [companies] have ability to pay, it’s the right thing to do,” he said.
Still, given such extreme uncertainty about the economy's future, advocates say the Fed should be more stringent. Dennis Kelleher, chief executive of Better Markets, which advocates stronger market regulation, said the Fed shouldn’t allow any capital distributions by banks for at least a year.
“These aren’t just stress tests for Wall Street banks. These are credibility tests for the Fed,” Kelleher said.
Some Democrats and advocacy groups have also called on federal regulators to halt regulatory rollbacks launched under the Trump administration, warning that they could weaken banks during a deep economic downturn. Separately on Thursday, the FDIC finalized a rollback of a key post-financial crisis restrictions on risky trading, known as the Volcker rule.
“Trump’s financial regulators are not letting the pandemic and the economic catastrophe get in the way of their deregulatory agenda,” Kelleher said.
The banking industry had complained for years that the rule was too cumbersome. The changes adopted by the FDIC “will allow banks to further support the economy at this challenging time for the nation,” Rob Nichols, president of the American Bankers Association, said in a statement.
