US banks breeze through Fed stress tests.

Big U.S. banks have passed the Federal Reserve’s annual stress test, indicating that they have sufficient capital to withstand a severe economic downturn. This is a positive sign for the sector as it continues to recover from earlier turmoil and faces an uncertain economic outlook. The stress test exercise involved 23 banks, each with more than $100 billion in assets, and showed that they would experience a combined $541 billion in losses under the Fed’s severe downturn scenario. However, they would still have more than twice the amount of capital required.

Leading banks such as JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Morgan Stanley, and Goldman Sachs were able to sail through the stress test. Among the best performers were Charles Schwab Corp. and Deutsche Bank’s US operations, while Citizens Financial Corp. and US Bancorp were the laggards in the pack.

Fed Vice Chair for Supervision, Michael Barr, stated that the results demonstrated the strength and resilience of the banking system. However, he also emphasized that the stress test was just one measure of the sector’s health and highlighted the need to remain humble about potential risks.

The average capital ratio for the country’s eight “globally systemically important banks” stood at 10.9%, slightly higher than last year. State Street had the highest capital ratio among these banks at 13.8%.

Banks’ commercial real estate portfolios performed better than expected, with losses of $65 billion or 8.8% of average loan losses, down from last year’s 9.8%.

The positive results of the stress test prompted shares of major banks to rise in extended trading. Bank of America and Wells Fargo gained around 2%, while JPMorgan and Charles Schwab both added more than 1%.

Following the stress test, banks will be allowed to return excess capital to shareholders through share buybacks and dividends. However, analysts expect payouts to be slightly lower this year due to economic uncertainty and impending new capital rules. The banks will announce their specific plans after the close of trading on Friday.

Industry officials welcomed the results of the stress test, stating that they showed there was no need for tougher rules. Critics, on the other hand, have cautioned that the tests do not examine all potential weaknesses and do not cover many mid-size lenders who have faced liquidity crunches in recent months.

The Fed’s stress test assesses how banks’ balance sheets would fare against a hypothetical severe economic downturn. This year’s test came after turmoil in the banking sector due to Fed interest rate hikes, which caused large unrealized losses on banks’ U.S. Treasury bond holdings and worried uninsured depositors.

While the stress test is reassuring for some investors, it does not probe all potential weaknesses and does not examine many mid-size lenders. Additionally, the test’s results do not reflect the fallout from the crisis, as it examined bank balance sheets at the end of 2022.

Fed officials acknowledged that banks performed relatively well in the stress test because the scenario envisioned interest rates dropping rapidly, allowing large banks to shrink unrealized losses on their balance sheets and offset traditional loan losses. The scenario also included an 8.75% contraction in the U.S. economy and a 40% slump in commercial real estate asset values, resulting in a 10% jobless rate.

Overall, the stress test results provide a vote of confidence for big U.S. banks and indicate their ability to weather a severe economic slump. However, ongoing vigilance is necessary to ensure the banks’ resilience to various economic scenarios and potential risks.

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