The Federal Reserve on Thursday said it will lift COVID-era dividend and share buyback restrictions on the largest banks, potentially setting up big bank shareholders for a windfall of capital distributions.
The regulator announced results from its annual stress test on Thursday, declaring that all 23 of the tested banks appeared to have “strong capital levels” and would be able to withstand a severe recession.
The Fed had been imposing additional restrictions on the amount that large banks could pay out to shareholders in dividends and share repurchases. But it said in March that those restrictions would be lifted if banks met regulatory minimums in their stress tests.
By showing the Fed that they were capitalized above the regulator’s requirements, the largest banks — which include the likes of JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) — will no longer face restrictions on share buybacks and dividends after June 30.
Federal Reserve Vice Chairman for Supervision Randal Quarles said in a statement Thursday that the banking system looks “strongly positioned to support the ongoing recovery.”
The largest banks may immediately boost their planned dividends and share buybacks as a result of the Fed results.
Mike Mayo, a senior analyst at Wells Fargo, had said before the results that he expected all the tested banks to clear the test.
“We think banks will be allowed to return twice as much capital this year as opposed to the prior year,” Mayo told Yahoo Finance on Monday, projecting that large-cap banks could pay out $127 billion in capital this year (compared to $63 billion in 2020).
A gradual winding down of restrictions
Last year, the Fed capped dividend payments and restricted share buybacks entirely to “ensure large banks remain resilient despite the economic uncertainty from the coronavirus event.”
After an impromptu “sensitivity” analysis and a second round of stress tests, the Fed in December loosened those restrictions and allowed dividends and share buybacks — as long as the total payouts did not total more than an average of the bank’s net income over the prior year.
The expiry of those COVID-era restrictions does not impact the standing regulatory framework for the banking industry, which requires the largest firms to stay above their capital requirements. If any bank falls below minimums set by the “stress capital buffer” framework, the Fed imposes automatic restrictions specifically to that firm.
The Fed’s stress test for 2021 used a hypothetical “severely adverse” scenario where the U.S. economy saw GDP shrink by 4% with the unemployment rate rising to 10.75%, which Mayo described as tougher than that incurred during the Great Financial Crisis.
Senior Fed officials said the banks continued to show strong capital levels even after enduring an economic shock as unprecedented as COVID. Those officials also said the stress tests assumed steeper losses than those endured by all the banks exposed to the collapse of family office Archegos Capital in the spring.
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.