Following the initial results of the Federal Reserve’s annual stress test of large bank holding companies (BHCs), last week the Fed released the second part of its Comprehensive Capital Analysis and Review.
The vast majority of the 35 banks examined passed based on the Fed’s capital standards (though capital requirements are still quite low by historical standards, and need to be significantly higher to dramatically reduce the risk of a government bailout). Even so, by current standards, banks are doing fairly well:
U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio–which compares high-quality capital to risk-weighted assets–of the 35 bank holding companies in the 2018 CCAR has more than doubled from 5.2 percent in the first quarter of 2009 to 12.3 percent in the fourth quarter of 2017. This reflects an increase of more than $800 billion in common equity capital to more than $1.2 trillion during the same period.
Three BHCs were found to have insufficiently high (by the Fed’s standards) capital to make or increase dividend payments and stock buybacks: Goldman Sachs, Morgan Stanley, and the US branch of Deutsche Bank.
The two American banks were found to be sufficiently capitalized by a thin margin, 3.1% for Goldman and 3.3% for Morgan Stanley, compared to the Fed’s minimum requirement of 3%. However, because these banks’ low capitalization was due in part to changes made in 2017 Tax Cuts and Jobs Act, the Fed instead opted to allow these banks to make dividend payments and buybacks, though only at levels equal to last years’ payments ($6.3 billion for Goldman and $6.8 billion for Morgan Stanley.)
This plan was part of the Fed’s “conditional non-objection,” in exchange for a failing grade from the country’s largest financial regulator.
Deutsche Bank, on the other hand, was forbidden from transferring cash from its US subsidiary to its Frankfurt headquarters. Because Deutsche Bank is a foreign firm, the results of the stress test don’t necessarily limit the ability of the bank to make other stock buybacks or dividend payments, just the US division.