Fed says big banks can withstand recession, clears path for shareholder payouts

The US Federal Reserve announced on June 27 that all 22 of the nation’s largest banks have passed its 2025 stress tests, clearing the way for potential dividend hikes and stock buybacks. The results indicate that the financial system remains resilient, even under a hypothetical severe economic downturn, though the Fed's scenario this year was notably less severe than in 2024. “Large banks remain well capitalised and resilient to a range of severe outcomes,” said Michelle W. Bowman, the Fed’s Vice Chair for Supervision and a recent appointee by President Donald Trump.

The annual exam tested how banks would perform under a hypothetical global recession marked by a 30 per cent plunge in commercial real estate prices, a 33 per cent drop in home prices, and a spike in unemployment to 10 per cent. Despite projected losses of over $550 billion, including $158 billion from credit card defaults and $124 billion in commercial loan losses, all banks remained above regulatory minimum capital requirements.

The average common equity tier 1 (CET1) capital ratio dropped 1.8 percentage points under the stress scenario but still held strong at 11.6 per cent, more than double the minimum requirement of 4.5 per cent. Leading performers included JPMorgan Chase, which retained a 14.2 per cent capital ratio, and Charles Schwab, which posted the highest at 32.7 per cent. BMO’s US operations recorded the lowest, at 7.8 per cent, though still well above the regulatory floor.

Less intense test draws scrutiny

Compared to 2024, this year’s test scenario was milder, with less dramatic declines in asset prices and economic indicators. Last year’s test included a 40 per cent drop in commercial real estate, a 36 per cent fall in housing, and a 55 per cent plunge in stock prices. The more lenient approach prompted questions from analysts and policymakers, particularly around the lack of testing for private credit, a rapidly growing $2 trillion asset class that some researchers have flagged as a potential systemic risk.

The Fed defended the change by citing “unintended volatility” in prior results and said it plans to solicit public feedback and make future stress test models and scenarios more transparent.

In April, the Fed also proposed averaging results over two years to smooth capital requirement volatility. If adopted, this year’s results would be averaged with 2024’s, raising the projected capital decline to 2.3 percentage points.

Dividend and buyback plans coming soon

With the positive results, banks are now free to announce their capital distribution plans, likely starting next week. Analysts expect an uptick in share buybacks, which have already led to a 3 per cent drop in outstanding shares over the past five quarters among tested banks.

While the Fed’s results are reassuring, some analysts warn that more rigorous testing may be needed in future years to fully assess vulnerabilities in an evolving financial landscape.