federal reserve bank stress testing

Rocked by the global pandemic crisis this year, the U.S. financial system may well be roiled once again by recent events as the Federal Reserve conducted “stress tests” designed to gauge the viability of various banks.

These worst-case scenarios included pandemic-focused tests.

Once such scenario, one that depends on what economists call a “W-shaped” recovery, envisions a banking climate where economic restrictions are re-imposed in an attempt to slow the spread of the coronavirus.

The initial results of these tests were released at the end of last month, and experts worry that signs of weak performances from banks may impact banks’ ability to continue issuing their dividends.

A number of Fed officials have already called on banks to suspend those dividend payments altogether.

Call it “test anxiety” if you will.

The annual stress tests conducted by the central bank included a “coronavirus sensitivity analysis” aimed at informing regulators will analyze their plans regarding dividend and buyback actions. Such moves reduce the amount of “capital buffers” banks have on hand during this pandemic.

The tests also included the effects from draw downs to corporate credit lines, moves that were made across the industry in late March and April as the coronavirus took hold.

Results of the pandemic sensitivity analysis will only be released in an aggregate form and not released with details for individual banks.

Four of the eight largest U.S. banks say they’ve already brought a halt to share buybacks as a result of the uncertainty caused by the coronavirus outbreak, and analysts say they believe those banks will hold that line through the end of the year.

Buybacks have been the main method banks used to return cash to investors over the course of the last few years. Citigroup alone bought back nearly $20 billion in shares during 2019. Citigroup also paid out more than $5 billion in dividends last year.

Banks who fail the central bank’s testing will be required to cut their shareholder payouts to 60% of “average retained net income.” Those cutbacks would be based on data reported by banks over the previous four quarters.

“Through June and the end of July we’ll have an opportunity to put [the stress-test results] together with the management team,” said Wells-Fargo Chief Financial Officer John Shrewsberry. “Then the board (will use those) to talk about whether it’s appropriate to do anything with that dividend.”

The result is likely to be that many large global banks will be required to cut dividends, at least according to analysts at RBC as 2020 is thought to be a particularly down year for bank earnings.

Among those major banks, RBC says Wells Fargo, JPMorgan, Citigroup and U.S. Bancorp are likely dividend cutters.

The Federal Reserve initially came up with the stress test structure in 2009 as a way to calm investors regarding the stability of banks following the mortgage meltdown in the U.S.  

Analysts and economists say that the Federal Reserve lacks all the answers to this and they add that government measures against the virus are what will matter most. They say how quickly the coronavirus pandemic is controlled is the major driver.

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