Banking

Fed extends dividend restrictions after stress test results

WASHINGTON — The Federal Reserve is extending restrictions on bank dividend payments and share repurchases into the first quarter of next year, but will still allow banks to make payments to shareholders based on income earned over the past year.

The Fed announced its decision as it released results of the first-ever “mid-cycle” stress tests. The central bank added the supplemental test in light of economic uncertainties from the coronavirus pandemic. The balance sheets of 34 banks with at least $100 billion of assets were assessed against a “severely adverse” and an “alternative severe” scenario, using data collected from after the onset of the pandemic.

The central bank also voted unanimously not to adjust any firm’s stress capital buffer, in an effort to prevent banks from having to raise additional capital in the midst of stressed economic conditions, according to senior Fed officials.

The analyses found that the firms in aggregate would achieve risk-based capital ratios well above the required minimum even under the most stressed circumstances, and that banks have actually built combined capital thanks both to the Fed’s earlier restrictions on dividend payments and to large loan-loss reserves.

However, a number of institutions were only able to meet roughly the minimum in their individual scores. And in a less severe scenario — envisioning a slow recovery coming out of the pandemic — 19 of the 34 banks were only able to achieve the minimum capital ratio that the central bank used as its basis. The institutions meeting just the minimum in the less severe scenario included Bank of America, Capital One, Credit Suisse and PNC. The other 15 exceeded the minimum standard.

In a statement, Fed Gov. Lael Brainard cited that performance as the reason for her dissent from the Fed’s decision to restrict dividends and share repurchases. She had also voted against the Fed’s earlier restrictions announced in June, arguing that more dramatic actions were warranted.

“For several large banks, projected losses take capital levels very close to the minimum requirement, in the range where banks tend to pull back from lending, even before payouts,” Brainard said. “Today’s action nearly doubles the amount of capital permitted to be paid out relative to last quarter. Prudence would call for more modest payouts to preserve lending to households and borrowers during an exceptionally challenging winter.”

In the most severe scenario — which envisioned a double-digit unemployment rate at the end of 2021 as well as a sharp global slowdown — the capital ratio of banks in aggregate would decline from 12.2% to 9.6%, well above the minimum 4.5% requirement.

However, the Fed found that under both of the tested scenarios, banks would still suffer more than $600 billion in total losses. The Fed cited the economic uncertainty stemming from the persistent pandemic as the primary reason for extending its restrictions on dividends and share repurchases.

Since the end of June, banks have not been allowed to repurchase shares and have had to limit dividend distributions to the levels banks paid out in the second quarter. But the Fed, in the first quarter of next year, will instead adjust the maximum amount banks can pay out and buy back to an amount based on income earned this past year.

If a bank did not earn income, it will be prohibited from paying out dividends or buying back shares entirely.

“The modified restriction will continue to preserve capital and ensure that large banks can still lend to households and businesses,” the Fed said in a release.

Although all of the banks tested met the minimum required common equity tier 1 capital under the most severe scenario, several banks’ projected capital only just met the minimum standard: DB USA (the U.S.-based affiliate of Deutsche Bank), HSBC North America, Ally Financial, BMO Financial Corp., BNP Paribas, Citizens Financial, M&T Bank and MUFG Americas.

In the alternative severe scenario — which contemplated a lower unemployment rate and lower decline in gross domestic product than the more severe scenario, but an overall slower recovery — 19 of the banks tested would only meet the minimum standard, including Bank of America, Capital One, Credit Suisse, PNC, Truist, Fifth Third, Huntington, KeyCorp, RBC and Regions.

Still, Fed Vice Chair for Supervision Randal Quarles called the stress test results an indication that banks have plenty of capital to continue supporting the economic recovery from COVID-19.

“The banking system has been a source of strength during the past year and today’s stress test results confirm that large banks could continue to lend to households and businesses even during a sharply adverse future turn in the economy,” he said in a statement.

Each of the 34 banks subject to the mid-cycle test also underwent the Fed’s regularly scheduled stress tests earlier this year. In aggregate, all of the banks tested in the spring maintained the minimum capital requirements under each of the scenarios — although “several would approach minimum capital levels,” the Fed had said at the time.

Although the Fed did not specify how long the restrictions on dividends would continue, it said it would “continue to evaluate the resiliency of large banks and monitor financial and economic conditions.”

Senior Fed officials added that there is no formula for determining whether or not to continue the restrictions into the second quarter of 2021, but that the Fed would make that decision in part based on the level of certainty about the path of the recovery.


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