The US Federal Reserve told the nation’s biggest banks they cannot increase dividends or resume buybacks through at least the third quarter as uncertainty over the course of the COVID-19 pandemic weighs on lenders.
The industry performed well in annual stress tests, according to a statement from the Fed on Thursday, but a separate review of the effects of the novel coronavirus on the economy and financial system uncovered potential risks that left the fate of their dividends in question.
The Fed “is taking action to assess banks’ conditions more intensively and to require the largest banks to adopt prudent measures to preserve capital in the coming months,” Fed Vice Chairman for Supervision Randal Quarles said in the statement. “The banking system remains well capitalized under even the harshest of these downside scenarios.”
The Fed capped dividends at second-quarter levels and said future payouts would be limited by a formula based on recent earnings.
That left Wells Fargo & Co, where profits slumped 89 percent in the first quarter, most at risk for a dividend cut. Earnings power at the San Francisco-based company has declined with the economic meltdown and, unlike many of its competitors, Wells Fargo does not have a sizable trading operation benefiting from market volatility.
Under the new rule, a bank’s dividend cannot exceed average quarterly earnings for the previous four quarters.
There is still a chance Wells Fargo can continue paying a dividend. Assuming its second-quarter income is as low as in the first three months of the year, its average for the past four quarters would be US$2.2 billion, higher than the US$2.1 billion it paid in dividends in the first quarter.
Goldman Sachs Group Inc and Morgan Stanley fared the worst in the regular portion of the stress tests, with their capital levels declining 6.4 and 5.5 percentage points respectively, under a hypothetical economic crisis devised by the Fed.
Both firms were expected to do worse than other banks because their businesses are more reliant on capital markets, which take a heavier beating in the regulator’s crisis scenario.
This year’s stress tests included a new “sensitivity analysis” that sought to capture how financial firms are positioned to handle financial pressure caused by the pandemic.
Those results were only released in aggregate form, showing how all the 34 banks being tested would fare under more severe scenarios.
Policymakers considered three potential scenarios. Results from a quick-recovery, V-shaped outcome echoed those of the regular stress tests, with the aggregate capital level of the firms dropping by 2.5 percentage points versus 2.1 in the analysis that did not take into account the pandemic.
However, a slower recovery would mean a much harsher impact, with the group’s capital declining 3.9 percentage points in the U-shaped rebound and 4.3 percentage points in the longest, W-shaped scenario, which assumes a second wave of coronavirus containment measures.
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