The Federal Reserve released the results of their annual stress tests on the nation’s biggest banks, and the positive impact can be a turning point in the stock market. Amid concerns that banks would not have enough capital to endure another financial crisis a la 2008, the results came through with flying colors and for the first time in 7 years, all 34 financial institutions passed[1]. The rigorous examination tests the stability and strength of these banks to withstand a severe recession. Each bank is put through a hypothetical scenario of harsh economic conditions– such as 10% unemployment or a GDP growth rate of -10.6%[2]. Regulators then determine whether the banks have enough capital to survive such conditions, as well as their ability to measure and manage risk when paying dividends or buying back shares.

Behind the positive results however, looms the ongoing campaign from the Trump Administration to reduce regulation. The Fed determines the minimum level of capital that banks must hold, and to pass these tests, banks must hold even more capital than they are required. With unemployment under 5% and GDP growing at 2%2, the tests in extremely dire situations can beg the question that the Fed’s capital requirements are perhaps too high. The Trump Administration campaigned on the premise of decreasing the Fed’s regulation, arguing that high capital requirements hinder bank’s ability to lend to small businesses and homeowners. This view differs greatly from Fed Governor Jerome Powell, who indicated that the Fed intends to further increase regulation and minimum capital requirements for the eight largest banks. In fact, recent data suggests that bank lending has increased to all-time high levels for commercial and industrial loans.[3] However, about 50% of loan applicants received smaller loans than requested, indicating that the conservative and risk-averse nature of bank lending is hurting the growth of younger and less proven applicants.

While the Fed will ultimately decide what direction capital requirements go in the future, investors can take comfort knowing that banks are strong enough to lend to households and business, even during a recession. Banks are now eligible to raise their dividends and buy back shares, which may help attract more investment in the future. Investors and shareholders of big banks can expect to see higher payouts in the coming weeks.

bank loan graph

Source: CNN Money

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.