The Fed limits bank dividend payments and suspends share buybacks for the third quarter after stress tests

On Thursday, the Federal Reserve voted in favor of requiring large banks to preserve capital by suspending share buybacks and dividend payments in the third quarter.

In a 4-to-1 vote, the Fed will tie dividend distribution to a formula based on recent earnings. The formula establishes the third quarter dividends at a level equal to the average net income for the last four quarters. Fed Governor Lael Brainard disagreed with the decision.

Based on that calculation, some banks may have to reduce their dividends. A senior Fed official said this could be “binding” for some banks.

In his dissent, Brainard said: “I do not support giving the green light to big banks to deplete capital,” he said, arguing in exchange for a general dividend suspension.

A senior Fed official said the Fed will move quarter to quarter. And banks’ net income could be reduced given the impact of the pandemic. Stress tests cover 34 banks, including five foreign companies.

The Fed released two studies: a traditional stress test established in February before the pandemic and an analysis of bank capital under three ways the economy could evolve in the coming quarters amid the public health crisis, more or less in V-shaped, U-shaped, and W-shaped scenarios.

The traditional stress test showed that all large banks remain well capitalized.

Under the worst-case scenario for COVID-19, “many” banks would be operating within their stress capital buffers and a quarter of banks would be approaching minimum capital standards, Brainard said.

“Past experience shows that banks operating near their regulatory minimums are much less likely to meet the needs of creditworthy borrowers, and the tightening resulting from credit conditions could affect the recovery,” he added.

The Fed said it would require banks to reevaluate their capital needs and resubmit their capital plans later this year.