Investing.com - This week, the Federal Reserve will present its annual stress tests results, which measure the ability of banks to maintain adequate capital during severe economic downturns. Following a tumultuous year that saw the failure of Silicon Valley Bank and two other lenders due to interest rate hikes and losses on U.S. Treasury bonds, analysts expect that major financial institutions will still demonstrate sufficient capital reserves.
Although Wall Street giants like Citigroup Inc (NYSE:C), Bank of America Corp (NYSE:BAC), JPMorgan Chase & Co (NYSE:JPM), Goldman Sachs Group Inc (NYSE:GS), Wells Fargo & Company (NYSE:WFC), and Morgan Stanley (NYSE:MS) are often at the center of attention during these tests; smaller lenders such as Capital One Financial Corporation (NYSE:COF), U.S. Bancorp (NYSE:USB), and Citizens Financial Group Inc (NYSE:CFG) may also be under scrutiny this time around.
Despite facing their toughest examination in years with increasingly challenging scenarios outlined by the Fed's "severely adverse" scenario predictions including significant increases in unemployment rates and commercial real estate prices plummeting by 40%, bank analysts remain optimistic about passing outcomes for all 23 participating institutions.
Wells Fargo analysts recently stated that dividends should remain secure while excess capital could still be returned to shareholders under most circumstances – albeit at a slower pace than before.
The banking industry has performed well in recent years; however critics argue that earlier stress test iterations failed to adequately account for potential weaknesses caused by rising interest rates. Last year's exercise estimated a combined loss of $612 billion across tested banks during an extreme economic downturn but concluded they would retain double the required capital under federal regulations.
For this year’s test overseen by Michael Barr who succeeded Randal Quarles as Vice Chair for Supervision at the Fed since last year’s review was conducted without one appointed - new elements have been introduced including multiple scenarios aimed at making assessments more dynamic alongside an “exploratory market shock” for the eight largest and most complex banks.
Although hypothetical losses are anticipated to be higher than last year, with average capital levels expected to decline by 3.2% compared to 2022's decrease of 3%, analysts predict that caution surrounding economic uncertainty and upcoming capital hikes will likely lead banks to adopt a more conservative approach regarding payouts in 2023.