Stress test results set to push capital requirements higher

Projected losses increased at the vast majority of the 31 large banks in this year's Federal Reserve stress test relative to their most recent previous assessments and are likely to translate into higher capital requirements.

For the banks in the aggregate, the common equity Tier 1 (CET1) ratio fell by a maximum of 2.8% in the simulation, compared with 2.5% in 2023 and 2.7% in 2022. The Fed said the stress scenario used this year is about the same as last year, and that the higher losses reflect rapid growth in credit card loans and a deterioration of credit performance in those portfolios, growing risk in corporate portfolios reflected in banks' own ratings of their loans, and a recent decline in noninterest net revenue that carries into projections of bank earnings that are available to absorb credit losses.

"The test resulted in higher losses because bank balance sheets are somewhat riskier and expenses are higher," Vice Chair for Supervision Michael Barr said in a statement. "These larger losses may inform an increase in capital requirements."

The stress test determines a key component of capital requirements for big banks, the stress capital buffer (SCB), which is mostly tied to estimated losses. This year's results, which were published June 26, represent a headwind to share repurchase outlooks. Analysts have been expecting repurchases to accelerate after recent capital builds, even as banks remain cautious while regulators work toward potentially tougher requirements under the Basel III endgame.

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Estimated capital deterioration increased at all but seven banks relative to their previous test. Participants on the smaller end of the large bank spectrum are mostly tested every two years, so changes in their estimated losses, and the SCB requirements they determine, are mostly relative to 2022. Estimated CET1 deterioration at some banks is well below the minimum 2.5% for the SCB, so modest changes in the results for these banks do not impact their requirements. Capital deterioration was less than 1.5% at five banks, including American Express Co.

At JPMorgan Chase & Co., which has been warning that it believes its SCB is cyclically low, estimated capital deterioration increased by 0.4 percentage point, after falling 1.2 percentage points the year before. At Citigroup Inc. by contrast, estimated capital deterioration fell by 0.2 percentage point after increasing the year before.

M&T Bank Corp., which has been reducing its concentration in commercial real estate lending, also saw a reduction in its estimated capital deterioration by 0.1 percentage point. Its commercial real estate loan loss ratio actually increased relative to the stress test in 2023, but the estimate for its pre-provision net revenue increased.

Broadly, the annual stress test is designed to assess big banks' ability to keep lending during a harsh recession. This year's "test showed that while large banks would endure greater losses than last year's test, they are well positioned to weather a severe recession and stay above minimum capital requirements," the Fed said.

Senior Fed officials said the deterioration this year reflects normal variation that should be expected.

However, the maximum decline in the aggregate CET1 ratio was the largest since 2018 and follows a run of favorable performance in bank stocks after recent stress tests.

Bank stocks outperformed the day after stress tests during the three previous years, with banks whose results improved from the previous year outperforming those that did not in 2023, Jefferies analysts said in a note June 24. The Fed posts results after markets close.