Question

Fed Caps Big Banks’ Dividends, Halts Share Buybacks in Fourth Quarter

Central bank extends restrictions on dividends, buybacks, amid cloudy economic outlook

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WASHINGTON—The biggest U.S. banks will face restrictions on dividends and share buybacks for another three months, the Federal Reserve said Wednesday, citing the need to conserve capital during the coronavirus-induced downturn.

The Fed said it would maintain prohibitions on share buybacks and a cap on dividend payments by 33 banks with more than $100 billion in assets until the end of year. The restrictions, imposed for the third quarter, were due to expire Wednesday.

The action is intended to “ensure that large banks maintain a high level of capital resilience,” the central bank said in a statement. “The capital positions of large banks have remained strong during the third quarter while such restrictions were in place.”

In another sign of the uncertainty facing the industry and the broader economy, the Fed has required big banks to undergo a second round of so-called stress tests later this year, based on two coronavirus-related recession scenarios. Results of the tests, designed to ensure banks can continue to lend in a crisis, will be announced by the end of the year.

Banks are in a much stronger position now than they were during the financial crisis of 2008. But an analysis the Fed conducted this summer found that if the economy takes a long time to recover, banks could experience losses on a similar scale. It said at the time that limiting shareholder payouts would help keep banks healthy during the recession.

The biggest U.S. banks, including Bank of America Corp. and JPMorgan Chase & Co., had already voluntarily halted share buybacks through the second quarter. Buybacks are the main way U.S. banks return capital to shareholders. Under the dividend restrictions, banks won’t be able to make payouts that are greater than their average quarterly profit from the four most recent quarters.

The Fed’s restrictions come as many bank shares have plunged as the coronavirus pandemic took a toll on banks’ bread-and-butter lending businesses. Short-term interest rates near zero and tens of billions of dollars set aside to cover bad loans have cut into profits.  

Bank executives “are biting their tongues with the Fed, with fingers crossed they can buy back stock someday soon at these cheap prices,” said Christopher Marinac, director of research for Janney Montgomery Scott LLC.

The Fed’s decision to allow banks to continue paying dividends drew a dissent from Lael Brainard, an Obama appointee still on the Fed board, who has said allowing banks to deplete capital buffers could force them to tighten credit in a protracted downturn.

Some former U.S. regulators have said the Fed should order the largest banks to suspend payouts to preserve capital at a time of soaring unemployment and business disruption that may eclipse the 2008 financial crisis.

“If things work out well, banks can distribute income later on,” Janet Yellen, a former Fed chairwoman, told The Wall Street Journal this spring. “If not, they’ll have a buffer that will be needed to support the credit needs of the economy.”

The Fed committed earlier this month to support the economic recovery by setting a higher bar to raise interest rates and by signaling it expected to hold rates near zero for at least three more years.

In new projections released after a two-day policy meeting in mid-September, all 17 officials who participated said they expect to keep rates near zero at least through next year, and 13 projected rates would stay there through 2023.

Shareholders like dividends and share buy backs. Explain what dividends and share buy backs are and what limits the Federal Reserve has placed on bigShareholders like dividends and share buy backs. Explain what dividends a banks' ability to pay dividends and buy back shares, How do dividends and share buy backs affect a bank’s (or any corporation’s) resiliency, that is their ability to survive during an economic downturn.   (14 points. 7-8 sentences should be sufficient)

The Federal Reserve is concerned that paying large dividends and buying back shares may be imprudent for large banks and the economy at this time. Lael Brainard, a Federal Reserve official, and others felt the Federal Reserve should have imposed stricter limits than it did on the banks. What policy did Brainard want to see adopted?   Explain what Brainard is worried about and why – that is how would the economy be affected if Brainard’s fears come true? (10 points. 6-7 sentences)

Banks are frustrated (“biting their tongues with their fingers crossed”) about not being allowed right now to buy back their shares? What has happened to the banking business and bank shares that makes the present time an attractive time for banks to buy back their shares?   (9 points. 5-7 sentences.)

Answer 1

“The banking system remains well-capitalised under even the harshest of these downside scenarios — which are very harsh indeed,” Mr Quarles said.

The Financial Services Forum, which represents the eight biggest US banks, said the results of the exercises “underscore the strength, safety and resiliency of the nation’s largest banks”.

For the first time in at least eight years, the Fed made no objections to the capital planning processes at any of the banks, a relief for Credit Suisse which was the only bank censured last year, and Deutsche Bank, which was still considered to be in a “troubled condition” by regulators at the New York Fed in late March.

Under the pandemic scenario, their aggregate capital ratios would fall from 12 per cent at the end of 2019 to 7.7 per cent, assuming they paid zero dividends in 2020. Actual dividend payments for the first two quarters would have wiped another 50 basis points, or 0.5 percentage points, from their capital ratios.

The Fed warned that under the most severe scenario — a double-dip recession with gross domestic product falling 12.4 per cent and unemployment peaking at 16 per cent — the weakest quartile of banks would post aggregate capital ratios of 4.8 per cent, a whisker above the 4.5 per cent regulatory minimum.