Federal Reserve ‘stress tests’ show some banks may struggle amid pandemic

Banking regulators are stepping up oversight, but continue to repeal rules that are supposed to prevent a recurrence of the “too big to fail” crisis that led to massive bailouts of the financial industry after the Great Recession.

On Thursday, the Federal Reserve completed “stress tests” to determine whether or not banks could survive a protracted economic downturn, and determined that the pandemic could push some to the brink in the worst case scenario.

The Fed told banks that they cannot buy back their own shares until the third quarter of the year and imposed limits on how much they can pay in dividends. Also Thursday, the Fed, along with the Office of the Comptroller of the Federal Currency and Deposit Insurance Corporation, relaxed the Volcker Rule, a 10-year restriction introduced in the wake of the financial crisis that banned banks from making certain gambling risks. investment.

“I think you have seen a broader vision of a bank as more of a utility company rather than a private investor operation,” said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

Elson said decisions about how banks use their money should rest with executives and boards of directors. “When you are threatened with failure, people do a better job,” he said.

But others say banks are fundamentally different in the sense that they operate more as an essential utility, and any collapse would be catastrophic.

“For better or for worse, and you have to keep the banks healthy enough.”

“Banks are a little different than normal business. The banking sector is special because it provides liquidity to the economy, ”said Bryan Routledge, associate professor of finance at Carnegie Mellon University.

The Fed has relied heavily on the financial services industry to carry out preliminary work to support borrowers during the COVID-19 pandemic.

“There are very real concerns regarding the health of the bank in particular, especially how they have been used for some of the loan programs. There will be some big write-downs associated with some of that, and the money has to come from somewhere, ”said Joseph Mason, a professor of finance at Louisiana State University.

“For better or for worse, and you have to keep the banks healthy enough to play their part,” Mason said.

Banking industry watchers, and even some policymakers, have characterized the stress test results as a red flag, saying that the limits on capital distribution through buybacks and dividends don’t go far enough to ensuring that banks are strong enough to withstand a prolonged recession.

Watch groups also criticized the timing of the relaxation of the Volcker Rule.

“Increasingly, it looks like there will soon be a massive wall of credit defaults, and the Federal Reserve is asking banks to remove their seat belts and step on the gas,” said Tyler Gellasch, executive director of the Association for Healthy Markets.

“Regulation is complicated because bankers want the benefit of having that support from the Federal Reserve, but they also want to make money,” Routledge said. “So if they risk a lot and win, they make big profits, and if they take big risks and lose, the taxpayers end up bailing them out.”