On Thursday, the Federal Reserve banned more than 30 large US banks from repurchasing its shares and limited the size of dividends they could pay to shareholders due to the financial stress of the coronavirus recession.
The Fed’s announcement came when the central bank released the results of the 2020 stress tests required by the Dodd-Frank Wall Street reform law passed in the wake of the 2007-09 financial crisis.
The Fed evaluated banks on their ability to withstand two hypothetical scenarios: a baseline of typical economic conditions and a “severely adverse scenario,” and three specific coronavirus situations: a V-shaped recession and recovery; slower U-shaped recession and recovery; and a W-shaped double-dip recession
While the 33 banks subject to the 2020 Fed stress tests met the standards to demonstrate that they could retain enough capital to remain solvent through a deeper crisis, the Fed said several banks approached lows. of cash reserves required by Dodd-Franco.
For that reason, the Fed is ordering banks to suspend any planned share buybacks during the third quarter of 2020 and limit the size of dividends at least during that time.
“Today’s actions by the Board to preserve high levels of capital in the United States banking system are recognition of both the strength of our largest banks and the high degree of uncertainty we face,” said the vice president of oversight. from the Fed, Randal Quarles.
“If circumstances warrant, we will not hesitate to take additional policy steps to support the economy and the banking system of the United States. I support today’s actions to ensure that banks remain a continuing source of strength for the United States economy, “he added.
The unprecedented speed and scale of the pandemic recession is the first important test of the stricter banking regulations imposed after the 2007-08 financial crisis. Unlike in 2008, banks have remained largely resilient in the face of the broad shutdown of the United States economy, thanks in part to record-breaking fiscal and monetary stimulus.
The Fed also faced challenges in properly evaluating banks on their abilities to withstand the uncertain path of the coronavirus recession. The current unemployment rate of 13.3 percent is actually 3.3 percentage points above the level of unemployment included in the Federal Reserve’s severely adverse scenario.
“In mid-March, it became clear that the COVID event was disrupting economic activity in the US. and that even the most extreme negative results than the seriously adverse 2020 scenario were plausible, especially for short-term unemployment and gross domestic product (GDP), “the Fed said Thursday.
Specific tests evaluated banks on how they could handle the unemployment rate, which soared to 19.5 percent and GDP fell to an annualized rate of 31.5 percent in the second quarter of 2020.
14.7 percent unemployment in April would probably have been 5 percentage points higher if it hadn’t been for a ranking error, according to the Bureau of Labor Statistics, and second-quarter GDP is projected to have fallen near the worst-case scenario. the Fed coronavirus.
The Fed said the analyzes related to the coronavirus should not be taken as official projections, but rather a range of potential results intended to help banks prepare for a deeper recession.
“As a result, the Board is taking steps to assess bank conditions more intensively and require larger banks to take prudent steps to preserve capital in the coming months,” said Quarles.
But Fed Governor Lael Brainard, the only Democrat on the central bank’s board of governors, opposed the decision to allow banks to distribute dividends, citing the uncertainty facing the economy.
“It is a mistake to weaken banks’ strong capital reserves when they are clearly demonstrating their value in the first serious test since the global financial crisis. This is a time for large banks to retain capital so that they can be a source of strength in a solid recovery, “Brainard said in a statement.
“I do not support giving the green light to big banks to deplete capital, increasing the risk that they will need to adjust credit or rebuild capital during the recovery,” he added. “This policy does not learn a key lesson from the financial crisis and I cannot bear it.”
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