The US Federal Reserve is considering whether to extend restrictions on dividends and share buybacks that it imposed on large banks after determining that the pandemic could trigger up to $700bn in losses for the lenders.
The US central bank had acted in June to ban share buybacks by the banks and cap their dividends for the third quarter. It said at the time that the large banks were “sufficiently capitalised” but that “heightened economic uncertainty” meant they should act “to preserve their capital levels in the third quarter”.
The Fed said on Thursday it would “announce by the end of September whether those measures to preserve capital will be extended into the fourth quarter”, highlighting its concerns about the US economy and the prospect for fresh turmoil in financial markets.
The central bank disclosed its deliberations as it laid out details of a new round of stress tests, in which the Fed will analyse the ability of lenders to withstand two scenarios.
The first has the jobless rate peaking at 12.5 per cent at the end of 2021, compared with the current rate of 8.4 per cent, before falling below 8 per cent in 2023, with a “sharp slowdown” internationally. In the second scenario unemployment does not spike as high, but drops more slowly and stays above 8 per cent in 2023.
“The Fed’s stress tests earlier this year showed the strength of large banks under many different scenarios,” said Randal Quarles, the Fed vice-chair responsible for financial regulation. “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.”
The Fed’s own economic projections show a more optimistic path for the US economy, with unemployment dropping to 5.5 per cent by the end of next year, and to 4 per cent by the end of 2023. But there is still plenty of nervousness about the trajectory of the economy and potential spillovers to the financial sector within the US central bank.
Lael Brainard, a Fed governor, had called for the US central bank to be even more strict in the wake of the June stress results, arguing that dividend payments should be banned entirely rather than capped.
She said the Fed’s very dovish new monetary policy framework — which would allow inflation to moderately overshoot its target before any tightening of policy — could increase “risk appetite, reach for yield behaviour and incentives for leverage”.
“It’s vital to use macroprudential as well as standard prudential tools as the first line of defence in order to allow monetary policy to remain focused on achieving maximum employment and 2 per cent average inflation,” she said.