The Federal Reserve’s stress tests of big banks found all 33 have enough capital to withstand a severe economic shock, though Morgan Stanley trailed the rest of Wall Street in a key measure of leverage.
The results mark the second straight year all firms passed the annual exams’ first phase. The biggest cleared the most severe scenario handily, with one exception. Morgan Stanley’s projected 4.9% leverage ratio tied for last place alongside a Canadian bank’s U.S. unit, falling within a percentage point of the 4% minimum.
Since starting the annual tests after the 2008 meltdown, the Fed has used the process to force firms to build up capital. The exams subject banks to Fed-invented hardships and are the cornerstone of the regulator’s efforts to ensure lenders can sustain another financial crisis. The results announced Thursday will be followed next week by the Fed’s release of a more closely watched measure that determines whether banks can make proposed payouts to shareholders.
“The nation’s largest bank holding companies continue to build their capital levels and improve their credit quality, strengthening their ability to lend to households and businesses during a severe recession,” the Fed said in a statement.
This year, the hypothetical scenarios were seen as especially tough, calling for banks to assume — in the most severe case — that U.S. unemployment doubled to 10% while the markets tumbled and Treasury yields went negative. The banks would have experienced resulting loan losses of $385 billion, according to the Fed.
In a lesser “adverse” event, the banks contemplated a minor U.S. recession and mild deflation, while a third was a baseline that tracked the average projections of economists. The scenarios also included some extra hardships for big trading firms, as they had to assume market shocks and trading-partner woes on top of the other troubles.