A worst-case scenario for the U.S. economy ravaged by the coronavirus pandemic would cause nation’s 34 largest banks to collectively lose roughly $700 billion, the Federal Reserve said Thursday.
To bolster the banks ahead such a potentially damaging recession, the Fed ordered the banks to suspend buybacks of their own stock and halt dividend payouts until Sept. 30.
The move comes as the central bank unveiled its latest “stress tests,” which are designed to test the resiliency of the nation’s largest banks. The annual tests change every year, and passing the tests is a requirement for the banks to start buying back shares or paying out dividends.
Typically the Fed’s testing parameters are hypothetical — an international debt crisis or a deep recession. But this year, the Fed based its tests around a very real, and ongoing scenario — the coronavirus pandemic. In the most dire of tests the U.S. unemployment rate would peak at 19.5%.
The Fed tested the banks using an economic model simulating a quick downturn and quick recovery, often called a “V-shaped” recession, as well as a slower U-shaped recovery. In the V-shaped scenario, the U.S. economy would contract 31.5% on an annualized basis, only to recover through 2020 and 2021.
The Fed’s worst case scenario, a double-dip recession, would have caused roughly a quarter of all the biggest banks to breach their minimum capital requirements. This scenario would show the U.S. economy contracting by 37.5% on an annualized basis and start to recover through the summer, but a second outbreak of infections would cause the U.S. economy to slip back into recession.
The Fed, as part of its announcement, also said it would suspend the banks from buying back their own shares at least until Sept. 30. Some banks were already doing this, but those voluntary limits would come to an end in the next two weeks. Further the Fed is capping these banks from paying dividends and requiring each bank to revisit their long-term capital plans.
“Today’s actions by the board to preserve the high levels of capital in the U.S. banking system are an acknowledgement of both the strength of our largest banks as well as the high degree of uncertainty we face,” said Federal Reserve Vice Chair Randal Quarles, in a statement.