Three U.S. banks were found by the Federal Reserve to be undercapitalized in a hypothetical financial crisis, thanks in part to the one-time effects of the Trump tax cuts.
Capital levels for Goldman Sachs, Morgan Stanley and State Street fell below the regulatory minimums during the financial crisis scenario presented in the Fed’s “stress test.”
That happened in large part because of aspects of the GOP tax cuts that were implemented right before the Fed collected the data for the tests, leaving the banks without time to revamp their plans. The tax law could have hurt earnings for a couple of reasons. One is that the lower tax rate means that deferred tax assets are worth less in the future. The other is that the law put some new limits on companies’ ability to apply losses in one year to taxes in another.
The particular ways that the tax law hurt the banks on the stress tests can’t be detailed because the Fed won’t comment on the business of specific firms.
But because Goldman Sachs, Morgan Stanley, and State Street fell short of capital requirements because of the one-time tax hit, the Fed gave them a conditional passing grade rather than a failing one. Those firms will now be limited in their ability to distribute capital to investors. Following the stress test decisions, Goldman Sachs announced $6.3 billion in distributions, while Morgan Stanley announced $6.8 bilion.
JPMorgan Chase, KeyCorp, M&T Bank, and American Express also fell short of capital minimums, but were able to resubmit their plans for capital distributions during the stress tests, and got passing grades on the resubmitted plans. JPMorgan Chase announced a $20.7 billion buyback program.
Capital requirements mandate that banks rely less on borrowing and more on ownership stakes like shares to fund their operations. The logic behind minimum requirements is that banks with higher capital can suffer more losses without failing to pay creditors and creating a panic.
The Fed said that the 35 banks that go through the stress tests have increased their common equity capital by $800 billion since 2009 to $1.2 trillion, more than doubling capital relative to risk-weighted assets.
Several other banks, including JPMorgan Chase, were also forced to revise their plans for paying out investors in order to pass the tests.
Only one bank failed the stress test outright: The U.S. arm of Deutsche Bank, a German bank. Deutsche Bank was flagged on the grounds of poor management, with the Fed faulting its handling of stock buybacks and dividend payouts as well as its forecasting.
The Fed claimed that the results, overall, demonstrate the health of the banks and their ability to withstand another crisis.
“Even with one-time challenges posed by changes to the tax law, the [stress test] results demonstrate that the largest banks have strong capital levels, and after making their approved capital distributions, would retain their ability to lend even in a severe recession,” said Randal Quarles, the central bank’s vice chairman for supervision.
