Federal Reserve releases details for round two of bank stress tests, considers extending dividend cap

Last modified September 17, 2020. Published September 17, 2020.

The U.S. on Thursday laid out details for its second round of stress-testing for 34 of the country’s largest banks, as it considers extending dividend-payment caps to ensure their solvency.

The unprecedented second stress test in a single year will predict whether the banks will still be able to lend to customers and businesses under challenging economic conditions that could be brought on by the pandemic. It also will be the first time the Fed provides firm-specific results for stress-test performances.

Under one scenario, U.S. unemployment will peak at 12.5% at the end of 2021 before falling to 7.5% near the end of 2023; GDP will also contract 3% by the end of 2020. The other scenario will simulate unemployment as peaking at 11% by the end of this year — with GDP falling 2.5% — but dipping only to 9% in 2023. 

In comparison, U.S. unemployment was 8.4% in August and peaked at 14.7% in April.

Some banks with a large international presence will additionally need to simulate a global market shock or the default of their largest trading partner.

“Although the economy has improved materially over the last quarter, uncertainty over the course of the next few quarters remains unusually high, and these two additional tests will provide more information on the resiliency of large banks,” said Randal Quarles, vice chair for supervision of the Federal Reserve.

The results of the first stress test, released in June, showed that large U.S. banks would face heavy losses from the pandemic but remain well-capitalized under harsh economic economic scenarios. Regardless, the Fed mandated that the banks suspend share repurchases and cap dividend payments to preserve their capital. 

Furthermore, in August, the central bank issued custom capital requirements to the 34 banks for the first time, using their stress-test results to calculate the standards.