Federal Reserve says 23 biggest banks weathered severe recession scenario in stress test

All 23 of the U.S. banks included in the Federal Reserve’s annual stress test weathered a severe recession scenario while continuing to lend to consumers and corporations, the regulator said Wednesday.

The banks were able to maintain minimum capital levels, despite $541 billion in projected losses for the group, while continuing to provide credit to the economy in the hypothetical recession, the Fed said in a release.

Begun in the aftermath of the 2008 financial crisis, which was caused in part by irresponsible banks, the Fed’s annual stress test dictates how much capital the industry can return to shareholders via buybacks and dividends. In this year’s exam, the banks underwent a “severe global recession” with unemployment surging to 10%, a 40% decline in commercial real estate values and a 38% drop in housing prices.

Banks are the focus of heightened scrutiny in the weeks following the collapse of three midsized banks earlier this year. But smaller banks avoid the Fed’s test entirely. The test examines giants including JPMorgan Chase and Wells Fargo, international banks with large U.S. operations, and the biggest regional players including PNC and Truist.

As a result, clearing the stress test hurdle isn’t the “all clear” signal its been in previous years. Still expected in coming months are increased regulations on regional banks because of the recent failures, as well as tighter international standards likely to boost capital requirements for the country’s largest banks.  

“Today’s results confirm that the banking system remains strong and resilient,” Michael Barr, vice chair for supervision at the Fed, said in the release. “At the same time, this stress test is only one way to measure that strength. We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.”

Losses on loans made up 78% of the $541 billion in projected losses, with most of the rest coming from trading losses at Wall Street firms, the Fed said. The rate of total loan losses varied considerably across the banks, from a low of 1.3% at Charles Schwab to 14.7% at Capital One.

Credit cards were easily the most problematic loan product in the exam. The average loss rate for cards in the group was 17.4%; the next-worst average loss rate was for commercial real estate loans at 8.8%.

Among card lenders, Goldman Sachs‘ portfolio posted a nearly 25% loss rate in the hypothetical downturn — the highest for any single loan category across the 23 banks— followed by Capital One’s 22% rate. Mounting losses in Goldman’s consumer division in recent years, driven by provisioning for credit-card loans, forced CEO David Solomon to pivot away from his retail banking strategy.

The group saw their total capital levels drop from 12.4% to 10.1% during the hypothetical recession. But that average obscured larger hits to capital — which provides a cushion for loan losses — seen at banks that have greater exposure to commercial real estate and credit-card loans.

Regional banks including U.S. Bank, Truist, Citizens, M&T and card-centric Capital One had the lowest stressed capital levels in the exam, hovering between 6% and 8%. While still above current standards, those relatively low levels could be a factor if coming regulation forces the industry to hold higher levels of capital.

Big banks generally performed better than regional and card-centric firms, Jefferies analyst Ken Usdin wrote Wednesday in a research note. Capital One, Citigroup, Citizens and Truist could see the biggest increases in required capital buffers after the exam, he wrote.

Banks are expected to disclose updated plans for buybacks and dividends Friday after the close of regular trading. Given uncertainties about upcoming regulation and the risks of an actual recession arriving in the next year, analysts have said banks are likely to be relatively conservative with their capital plans.