Fed caps dividends and bans buybacks by big US banks
The Federal Reserve temporarily restricted shareholder payouts by the nation's biggest banks, barring them from buying back their own stocks or increasing dividend payments in the third quarter as regulators try to ensure banks remain strong enough to keep lending through the pandemic-induced downturn.
The decision to limit payouts is an admission by the Fed that large financial institutions, while far better off than they were in the financial crisis, remain vulnerable to an economic downturn unlike any other in modern history. With virus cases across the United States still surging and business activity subdued, it remains unclear when and how robustly the economy will recover. Some of the Fed's own loss projections for banks, in fact, suggest that the eventual hit to loans in a bad scenario could be far worse than in the aftermath of 2008.
Still, the Fed stopped short of barring banks from paying dividends next quarter, as some lawmakers and former regulators have urged - a decision that drew public criticism from one of the Fed's current governors, who said not taking stronger measures could "impair the recovery."
The Fed, which devised its primary stress test scenarios before the virus tore through the economy, will require the 34 biggest banks to resubmit and update their capital plans later this year, something it has usually required only for banks that failed to pass. Those plans detail how the banks intend to proceed with share buybacks and dividend increases in light of the pandemic, and the Fed said that resubmitting them "will help firms reassess their capital needs." It will also allow the Fed to reserve the right to run additional analyses, and potentially restrict payouts further, down the road.
"Today's actions by the board to preserve the high levels of capital in the U.S. banking system are an acknowledgment of both the strength of our largest banks as well as the high degree of uncertainty we face," Randal K. Quarles, the Fed's vice chairman of supervision, said in a statement. The central bank's annual stress tests assess how the banks would fare under dire scenarios that include high unemployment and severe market turbulence. While those tests are meant to be hypothetical, this year's scenarios were set before the pandemic, and some of the economic projections now look benign compared to reality. To compensate for that, the Fed ran an additional analysis to gauge how the banks would perform under coronavirus recessions of varying severity.
The hypothetical scenarios included a sharp bounce-back, an extended "U"shaped downturn, and a double-dip "W" recession. After the close of the trading day on Thursday, the US Federal Reserve will reveal an unprecedented amount of data and commentary on America's top banks, with potentially far-reaching consequences for the institutions and their shareholders.
Its trio of announcements includes the annual stress tests showing how the top 34 banks would fare in a hypothetical crash, and another exercise examining whether the top 18 should be allowed to execute their dividend plans.
The results of those two exercises - launched in the wake of the 2008 crisis - are usually spaced out. This year they will both be on the same day because the Fed is introducing a new way of setting bank capital which has linkages to both exercises.
And, unusually this year, the Fed will also release data on how the top 33 banks as a group would perform in three looselysketched pandemic scenarios.*
Markets are skittish because coronavirus cases are on the rise again in the US and KBW analyst Brian Kleinhanzl said the Fed's "sensitivity analysis" on the pandemic's possible impact will be the main focus for bank investors.
Fed supervisory boss Randal Quarles sketched out the sensitivity analysis in broad terms last Friday. The Fed ran one scenario with a V-shaped economic recovery, which is essentially the same as the crash scenario in the regular stress tests, as well as a prolonged "U-shaped" recovery and a double dip "W-shaped" outcome.