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Fed warns of catastrophic impact of second wave on US banks


Michael Pinson, News Editor
29 Jun 2020, 3:39 p.m.


The United States Federal Reserve Board (FRB) has published the results of its supervisory-run Dodd-Frank Act Stress Test for the United States’ largest banks. As a result, a number of restrictions have been placed on US banks to try and ensure they have the capital to survive the current financial crisis.

The stress test is a simulation designed to determine the ability of 34 US banks, each with more than $100 billion in total consolidated assets, to deal with an economic crisis. Today Covid-19 is that financial crisis. Goldman Sachs Group and Morgan Stanley were hit the worst under the hypothetical adverse scenario.

They warned that loan losses could reach $700 billion across the 34 banks, and that while some had strong capital to protect them against such losses, several banks would be at risk of hitting minimum capital levels.

Of note, the stress tests did not incorporate any anticipation of further stimulus measures, or government spending. It also worked primarily on the idea of a V-shaped recovery, which would see the economy bounce-back from recession fairly quickly to pre-Covid levels; a recovery considered by many to be unlikely.

The US has recorded 2.4 million confirmed coronavirus infections and 122,370 deaths, though experts have warned that poor testing numbers means this is likely much higher in truth. There are worrying signs that numbers are only growing in America, with a number of states recording record numbers of cases, and re-imposing restrictions just a few weeks after opening.

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US Lockdown protestors

Protesters demanding the reopening of businesses over fears that recession will cause more harm than Covid-19.

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States like Texas have seen daily cases rising to 5,000 a day, and attempts to impose restrictions have resulted in protests, as seen in the image above. With efforts to bring numbers down failing, there will likely be further economic damage for the US throughout 2020.

Should this continue there are obvious concerns about the strength of America’s banking institutions, and its ability to deal with the situation. The failure of the banking world in the 2008 crisis is far from forgotten.

Indeed, the stress test and bank regulations were introduced in 2010 as a result of the 2008 crisis. This was after Lehman Brothers went under at the start of the subprime-collateralised debt obligation (CDOs) losses that led to the 2008 Wall Street crash.

Complex subprime loans made to high-risk house buyers, which totalled $640 billion, are now a thing of the past in the banking industry. However, similarly complex collateralised loan obligations (CLOs) to high-risk businesses continue today in financial services. No concrete figures are available from financial institutions, but in 2018 the Bank for International Settlements estimated these high-risk loans could total $750 billion.

In view of the huge economic disruption of coronavirus to investment banking the Fed is now imposing several restrictions, while also requiring the largest US banks to resubmit updated plans on their finances.

A statement from the FRB said, "All large banks will be required to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty".

The Federal Reserve is also requiring these big commercial banks to limit shareholder dividends, while suspending share repurchase schemes.

With the Stress Test release, Federal Reserve Governor, Lael Brainard, said, “This is a time for large banks to preserve capital, so they can be a source of strength in a robust recovery.” She went on, “I do not support giving the green light for large banks to deplete capital, which raises the risk they will need to tighten credit or rebuild capital during the recovery.

Fed Vice Chairman for Supervision, Randal Quarles, added, “If the circumstances warrant, we will not hesitate to take additional policy actions to support the U.S. economy and banking system.

After the failure of banks in 2008, the efforts of the Fed to keep these financial institutions strong is certainly welcome. Given the limited scope of the stress test however, many will question just how robust the results and subsequent required actions really are.

Having gained almost $100 per ounce in just under a month, many investors clearly share the same concerns over how strong the fiat system truly is, especially in light of the continued money-printing being done by Central Banks globally, and rising numbers of cases globally. With fiat money at risk, many are turning instead to physical bullion to protect their wealth.

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