During Federal Reserve health checks this week, major US lenders are supposed to show that they have enough capital to withstand any new banking sector upheaval, although analysts predict that investor payouts will likely somewhat decline as a result.
The central bank will announce the findings of its bank "stress tests" on Wednesday, which determine how much fund banks would require to weather a catastrophic economic slump.
The yearly exercise, which was instituted in the wake of the financial crisis that lasted from 2007 to 2009, is essential to banks' capital strategy since it determines how much money they can give back to shareholders in the form of dividends and buybacks of shares
Following the failure of Silicon Valley Bank as well as two other banks during this year's banking crisis, the 2023 tests will be conducted. Since they suffered significant unrealized losses of their holdings of US Treasury bonds as a result of the Fed's interest rate increases, uninsured depositors were alarmed.
Citigroup Inc., Bank of America, JPMorgan Chase, Goldman Sachs Group, Wells Fargo, and Morgan Stanley are among the Wall Street lenders that typically garner the most attention. Smaller lenders like Capital One, US Bancorp, and Citizens will certainly be under the spotlight as well, though, given the persistent investor anxiety around the industry.
The 23 lenders being examined are expected to have capital levels above the required minimums despite the unrest and the exam being the toughest in recent memory, according to bank executives and analysts.
The 2023 Fed Stress Test subjects banks to everything under the sun and enables them to demonstrate that the biggest banks are capable of passing one of the harshest examinations yet, according to a Thursday report by Wells Fargo analysts.
Banks should generally have additional capital to distribute to shareholders, though perhaps at a slower rate than in previous years, and dividends must be secure.
Although the Fed came under fire following the spring collapse of banks for failing to examine bank vulnerabilities for increasing rates in earlier tests, the industry has recently done well.
In a major economic downturn, the Fed estimated that banks would lose $612 billion in total, yet they would still have about twice the amount of capital required by Fed regulations. This was discovered last year.
The exam this year is more challenging. In contrast to 2022's 5.8 percentage point unemployment rate, the "severely adverse" scenario outlined by the Fed predicts a rise of 6.5 percentage points. As the real economy gets stronger and the actual unemployment rate in the United States declines in 2023, the test becomes harder.
The test will also take into account a 40% decline in commercial real estate prices, which is a bigger issue this year due to the stress that continues to be put on borrowers by the lingering office vacancies from the epidemic.
The size of a bank's "stress capital buffer" — an additional cushion of fund that the Fed mandates for banks to survive the fictitious economic downturn — depends on how well it performs, on top of the legal minimums needed to support normal activity. The buffer will grow in size as test losses increase.
The Bank Policy Institute, a Washington-based lobbying organization for banks, predicted on Thursday that this year's fictitious losses for banks will be a little higher. From 3% in 2022 to 3.2% in 2023, average levels of capital would decline, according to the forecast.
The exposure to commercial real estate, which RBC analysts projected would be a major factor in potential credit losses, will cause certain banks to have bigger buffers, they said earlier this month.
According to economists, banks will be a little more conservative about distributions this year as a result of that, and combined with upcoming new capital increases, and uncertainties regarding the economic outlook.
Given impending challenges, Jefferies analysts stated this month that capital return estimates were still being lowered.
The fact that the Fed was without a Vice Chair for Supervision after Randal Quarles left in 2021 contributed to last year's test being relatively straightforward. Michael Barr, his replacement, is in charge of the exams this year and has stated that he intends to add more variety to them by using various scenarios.
The eight biggest and most sophisticated banks, for instance, are experiencing a "exploratory market shock" this year. While this won't have an impact on capital, it will be considered when determining whether to use numerous scenarios in upcoming stress tests.
According to Barr in December, stress tests may quickly lose their value in a setting of ever-changing risks if their assumptions and scenarios stay static.