As regulators took a hard look at the U.S. banking industry, they found some of the nation’s largest financial institutions better prepared than others to sustain future market shocks.
The results of stress tests on Thursday, mandated by the Dodd-Frank financial overhaul law and conducted by the Federal Reserve, indicate that most banks would survive a severe recession and a crash in the markets. The tests, which measured a bank’s capital during extreme hypothetical conditions, also produced some unlikely winners —and one big loser.
Citigroup, for example, outperformed its rivals just one year after a poor performance embarrassed the bank. Bank of America also showed improved capital levels under stressed conditions.
Morgan Stanley and JPMorgan Chase, however, produced some of the lowest results among large Wall Street firms. The banks have significant trading operations that can rack up big losses in turbulent times. Goldman Sachs, another trading firm, also struggled under one measure of future health.
The results showed that, as a group, the nation’s 18 largest banks hold fewer bad loans compared with last year, helped by a stronger economy. The Fed will announce next week whether it will approve the banks’ plans to issue dividends or repurchase shares.
The Fed’s data show that one of the banks, Ally Financial Inc., would have a much lower capital buffer against losses than the others under the most severe scenario. Ally’s projected capital level is below the minimum that the Fed considers a bank would need to survive a severe recession.
The test results offer an important window into the financial system four years after the banking industry teetered on the brink of collapse. Regulators liked what they saw, in general, and cheered what the improvements portend for consumers and the economy.
“The stress tests are a tool to gauge the resiliency of the financial sector,” Federal Reserve Governor Daniel K. Tarullo said in a statement. “Significant increases in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty.”
But the tests may not fully capture some forces and events that occur during a financial crisis. For instance, Wall Street firms may lose access to short-term loans that are critical to their survival.
The stress tests will also prompt chatter on Wall Street, where investors will pore over the results to gauge how much money banks can likely return to their shareholders.
The results come one week before the Fed makes its final decision on Wall Street’s latest plans to ramp up shareholder payouts. Behind the scenes in the coming days, the Fed will signal to each bank whether it can proceed with its most recent payout plan, submitted in January. If the Fed objects, a bank will have an opportunity to temper its proposals for dividend payments and share buybacks before releasing the plans publicly, potentially creating a tense faceoff with regulators.