Fed says biggest banks could withstand severe economic downturn

On the first of two report card days for big banks in America, all but one bank received a passing grade from the Federal Reserve.

The central bank released the results of its “stress test” of 30 bank-holding companies with consolidated assets of $50 billion or more Thursday, showing that most of these institutions have enough capital to withstand a severe economic downturn.

This means that big banks may feel they can reward shareholders with dividends and stock buybacks, The Wall Street Journal reports.

Known as the Dodd Frank Act stress Test, DFAST, because it was enacted as part of the Dodd Frank legislation in the wake of the 2008 financial crisis, the test assesses how banks would fare under a “severely adverse” scenario. This year’s hypothetical economic storm? Imagine an unemployment rate over 11 percent, a greater than 4 percent decline in real GDP, a 50 percent drop in the stock market and residential and commercial real estate declines of 25 and 35 percent, respectively.

The idea is to catch early any bank that’s overleveraged and avoid another housing bubble or 2008 crisis. Having sufficient capital reserves is essential to the individual bank’s health and to the lending that supports the entire financial system. When banks can absorb their own losses, the the Fed points out, it’s shareholders, not taxpayers, who are left in a lurch.

Zions Bancorp, a regional bank in Utah, is the one bank that failed to pass the Fed’s test because they didn’t have enough capital, but as the Journal notes, several of America’s biggest banks, including Morgan Stanley and JPMorgan Chase, were relatively low in the ranking of bank capital levels. Bank of America was the lowest ranking of these bigger banks.

On Wednesday, the Fed will release the results of their second stress test — the Comprehensive Capital Analysis and Review, CCAR, in which they review the banks’ capital action plans for the next four quarters. If those plans are approved, the banks can release them to the public.