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Fed acts to keep banks ‘prudent’ amid virus risks

Federal Reserve

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The Federal Reserve has warned that America’s biggest banks could be hit by losses of up to $700bn (£563.6bn) in a severe downturn due to the pandemic.

The US central bank said it would require firms to keep money on hand to guard against the risks.

The Fed said it was barring share repurchases and limiting dividend payments until at least October.

Although banks have been a source of “strength” so far, officials warned of a “high degree of uncertainty”.

“Today’s actions…to preserve the high levels of capital in the US banking system are an acknowledgment of both the strength of our largest banks, as well as the high degree of uncertainty we face,” said Randal Quarles, the Fed’s vice chair for supervision of the Federal Reserve’s Board of Governors.

The announcement accompanied the results of the Federal Reserve’s latest annual stress tests, which were instituted after the financial crisis. The stress tests are designed to suss out potential weakness in the financial system.

This year, the Fed added an additional analysis based on the current downturn, which was set off when authorities instituted lockdowns to try to slow the spread of coronavirus.

Using a scenario where the pandemic severely impacted the US economy, the Fed looked at how the country’s 33 biggest banks would fare if unemployment rates were to climb to 19.5%.

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Federal Reserve Governor Lael Brainard thinks the Fed has not gone far enough in protecting US banks

That is higher than the record 14.7% unemployment rate the US reported in April – but about the level the Labor Department said was likely if it adjusted for discrepancies in survey data.

The Fed did not say how individual banks fared under the virus scenario, but warned that aggregate losses could reach $700bn.

“The Board is taking action…to require the largest banks to adopt prudent measures to preserve capital in coming months,” said Mr Quarles.

Not far enough?

Federal Reserve Governor Lael Brainard thinks that the Fed should have announced further measures given the potential losses at stake, by barring dividend payments altogether, as well as other distributions of capital.

The current shock is already more severe than anything the Fed had anticipated in its stress tests, despite past criticism that the central bank was being unrealistically gloomy, she noted.

“It is clear that recent changes in financial markets and the macroeconomic outlook could have a material impact on banks’ risk profiles and financial conditions,” she said.

“This action creates a significant risk that banks will need to raise capital or curtail credit at a challenging time.”

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