Fed Gives Banks Green Light for Buybacks after Stress Tests

The Federal Reserve has relaxed its limits on share buybacks for banks following a fresh round of stress tests.

The Fed announced late Friday that large banks had been shown to have “strong capital levels” following two rounds of stress tests conducted in the fourth quarter of the year.

From 1 January 2021, banks will be permitted to buy back shares provided that the total spent on share buybacks and dividend payments does not exceed their average quarterly income over the previous four quarters.

“The banking system has been a source of strength during the past year and today’s stress test results confirm that large banks could continue to lend to households and businesses even during a sharply adverse future turn in the economy,” said Randal Quarles, vice chair for supervision, last week.

The previous round of stress tests, conducted immediately following the onset of the pandemic in the US, found that banks “generally had strong levels of capital”, the Fed said. However, to preserve these in light of the Covid-19 pandemic, it placed limits on dividends and temporarily banned buybacks.

Since these restrictions have been in place, large banks have built up capital reserves and set aside a combined $100 billion in loan loss reserves.

The Fed’s most recent stress tests found that banks stood to lose more than $600 billion under its two hypothetical scenarios. However, while average capital ratios would fall from 12.2% to 9.6% in the more severe scenario, the Fed said this was still comfortably above its 4.5% minimum. All assessed banks’ risk-based capital ratios would remain above the required minimum, it added.

Combined net income declined in 2020 relative to 2019, the stress test found, but banks also reduced capital distributions and retained more of that income, through compliance with the Fed’s limits and their own reductions of dividends and buybacks.