Updated to reflect release of Fed's stress test

By Pete Schroeder

WASHINGTON, June 24 (Reuters) - The Federal Reserve announced on Wednesday that 32 of the nation's largest banks are well positioned to weather a severe economic downturn and continue lending, as firms could absorb over $700 billion in hypothetical losses and remain above minimum capital requirements.

The results of the central bank's annual "stress test" found large banks saw their capital levels fall 1.6%, but their levels remained in excess of the minimum requirements, even after weathering a global recession that saw real estate prices drop by a third, unemployment spike to 10%, and financial market turmoil.

"Today’s results underscore the strength of the banking system," said Fed Vice Chair for Supervision Michelle Bowman in a statement.

Under the test, banks saw roughly $200 billion in credit card losses, $160 billion in losses from commercial and industrial loans, and $75 billion in losses from commercial real estate. Under the exam, capital fell due to higher loan losses, as well as lower projected unrealized gains, but capital increased in the test due to higher interest income due to smaller hypothetical declines in interest rates.

Banks saw their aggregate high-quality capital ratio dip from 12.8% to a low of 11.2% during the exam. First Citizens recorded the lowest stressed ratio of 6.7%, while Charles Schwab Corp posted the highest ratio of 32.2%.

The results reflect the health of 32 banks, including JPMorgan and Bank of America, but are less dramatic than in prior years. The Fed said in February it would not use this year's results to update each firm's stress capital buffer, an added layer of capital large firms must hold that fluctuates based on how well they perform on the test.

The central bank reaffirmed that plan on Wednesday, saying it planned to next update that buffer following the 2027 test, after officials have solicited feedback and revamped their stress testing models and scenarios. The central bank is reworking its stress testing process in response to years of criticism from the banking industry that the exams are opaque and subjective.

With those buffers now holding steady, firms already have the information they need to make capital plans, including any potential stock buybacks or dividend changes. Raymond James analysts said in a note ahead of the results that they expect most banks to announce moderate dividend and stock buyback plans following the tests, noting that bank executives may opt for a more cautious approach given broader uncertainties.

"Despite the accommodative regulatory backdrop, we believe some management teams could be somewhat conservative given the aforementioned geopolitical/macro uncertainty and inflationary pressures," they wrote.

Rather, analysts say banks will likely wait to adjust plans until regulators have finished implementing several new capital rules favored by the industry, most notably the Basel proposal on risk-based capital under consideration.

Those changes could unlock billions of dollars in additional capital for banks to return to investors or deploy within their business.

"The industry is in good shape with capital, as all the names have excess capital relative to the implied pro forma target capital ratios and requirements as the industry continues to be in a position to take advantage of de-regulatory momentum," wrote KBW analysts in a note previewing the stress tests.