WASHINGTON (Reuters) – This year's Federal Reserve stress test results indicate a more flexible approach, another sign that the regulator's new leadership is responding positively to a Wall Street push for pragmatic banking supervision, analysts and lawyers said.
Banks that suffered a one-time capital loss as a result of the 2017 tax reform received a conditional passport, one Turning away from Fed's traditional strict pass-fail approach to quantitative capital issues, while the scandal-plagued Wells Fargo & Co could double share buyback plans.
Goldman Sachs and Morgan Stanley were hit as their capital fell below the minimum of the Fed, but the regulator's response this year sounded below Jerome Powell and Vice Chairman Randal Quarles, President Donald Trump's appointed analysts and lawyers, said friendlier.
"They have allowed companies to act on the basis of special circumstances and to apply pragmatism in the way they have not been in the past, this is the new Fed, and it signals a premature retirement of this extremely strict quantitative one Tests, "said Mike Alix, Risk Manager at PwC.
The Fed approved the capital plans of 34 lenders on Thursday after the second part of its annual test, a process introduced after the 2007-2009 financial crisis to assess banks' ability to weather a severe recession. The US Federal Reserve raised its worst-case scenarios each year.
The revised US tax code signed in December meant that Goldman's and Morgan Stanley's Thursday results were partially offset by changes in the treatment of past losses on hypothetical tax bills under the Fed's scenarios.
But with the tax issue unique and capital levels high in the system, the Fed found it unnecessary to fail the two banks, Fed officials said.
Under the conditional approvals for their capital plans, the two banks may pay out capital distributions but must keep them in line with previous years.
Some analysts pointed to the Fed's conditional approval of State Street Corp's higher dividend, although its counterparty risk in the scenarios was high.
"This confirms that the Federal Reserve was less draconian on how it reacted to the results," said Jaret Seiberg of Cowen Washington Research Group in a note.
Wells Fargo received approval for the highest payout ratio of the major US banks, which undermined investors' concerns that the test would fail to measure operational controls.
A temporary dip could signal clearer skies, according to Wellington Fargo and better relations with regulators, analysts at Evercore Group LLC said.
Democratic US Senator Sherrod Brown on Thursday criticized banks' payoffs to "wealthy shareholders" and warned the Fed not to relax their test procedures.
Lenders have long complained that the stress test process is too opaque and that the Fed has acted too hard on companies whose results are lagging behind models the Fed keeps secret.
Despite the Fed's pragmatic attitude towards Goldman Sachs and Morgan Stanley, industry insiders still doubt whether the regulator should have proceeded with the difficult scenarios this year in light of the short-term adverse tax changes and want further changes to make the process more transparent.
Powell and Quarles have said that stress tests could be more transparent and less discretionary, but banks continue to fear that loosening the Fed easing could not go far enough or inadvertently aggravate life if changes are not fine-tuned.
For example, they point to the Fed's April proposal to introduce a "stress capital buffer" that, together with the stress tests, would dissuade the system from a strict annual quantitative pass-fail procedure.
A blog post released on Friday warned The Clearing House banking group that the proposal as it was written could exacerbate their capital planning challenges by requiring banks to capitalize on stress losses throughout the year.
"This year's results show that capital requirements in the United States are very volatile from year to year, and that volatility is compounded by … the stress buffer," they added.
Reporting by Michelle Price and Imani Moise; Arrangement by Meredith Mazzilli