This year’s bank stress tests won’t be that difficult; future years are another story
By Aaron Back
Goldman Sachs is among the U.S. banks expected to face higher hurdles in the Federal Reserve’s stress tests next year. Photo: david gray/Reuters
U.S. banks are likely to sail through their stress tests this Friday, but the results are still important. They will determine their capital needs well into the future.
The stress-test process put in place after the financial crisis is changing. Under the Trump administration, the Federal Reserve has taken several steps to make it less onerous, such as by exempting many midsize banks and loosening assumptions on how much in buybacks and dividends banks are assumed to keep paying out during a crisis. But Fed regulators also are planning next year to throw banks a curveball known as the stress capital buffer, under which capital requirements will vary from year to year.
Analysts expect the nation’s top banks will all pass this year’s test with little difficulty, allowing them to announce big share buybacks and dividends next week when their capital plans are approved by the Fed.
In terms of macroeconomic assumptions, the Fed’s “severely adverse scenario” is somewhat harsher than last year, including a sharper rise in the unemployment rate. But the scenario regarding markets is less severe, aiding banks with big trading arms such as Goldman Sachs and Morgan Stanley .
The Fed assumes that U.S. stocks decline by 50%, less than the 65% crash envisioned in last year’s scenario, and that U.S. Treasury yields fall sharply along with equities, allowing banks to book some near-term gains on bonds held in their trading accounts.
There is another way in which Goldman and Morgan Stanley are in a better position this year: They have built up substantial capital after their near-misses last year, notes Wolfe Research analyst Steven Chubak. For instance, Goldman’s common equity Tier 1 capital ratio rose to 13.1% at the end of 2018 from 10.7% at the end of 2017.
That may be where the good news ends for the investment banks, though. Next year the tests will start incorporating the new stress capital buffer, in which a fixed 2.5% capital surcharge levied on the biggest banks is replaced by a variable surcharge based on the prior year’s losses in the stress test. This is set to hit the two pure-play investment banks particularly hard: Mr. Chubak estimates that Goldman’s surcharge will jump from 2.5% to 6.1%, and Morgan Stanley’s to 8.1%. By contrast, Bank of America ’ssurcharge is expected to be little changed.
These new rules have yet to be finalized and banks have been loudly complaining that the year-to-year variability in their capital requirements would be difficult to manage. The Fed could meet them halfway by basing the surcharge on average losses over a period of a few years, rather than a single year’s test.
If the Fed goes ahead with the plans as they are, though, then these annual tests are only going to get more stressful for top Wall Street banks.
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