How Did Banks and Investors Respond to the 2020 Stress Test Results?

Abstract

W. Blake Marsh is a senior economist at the Federal Reserve Bank of Kansas City. This article is on the bank’s website at www.KansasCityFed.org The COVID-19 pandemic heightened investor, regulatory, and supervisory concerns about the U.S. banking system’s ability to survive a downturn. Both businesses and consumers pulled back on economic activity at the start of the health crisis, leading firm revenue to decline sharply amid fears of rapidly accelerating job losses, business closures, and lower household incomes. As a result, expectations that businesses and consumers would be unable to continue servicing their debt obligations increased. Investors and bank supervisors began bracing for significant losses at banks, which could threaten the stability of the broader financial system. Policymakers moved quickly to backstop financial markets while supervisors tried to ensure banks could withstand the anticipated loan losses. In June 2020, the Board of Governors of the Federal Reserve System took steps to preserve capital at large banks by capping dividend payments to shareholders and prohibiting common stock repurchases outright for some time. In doing so, supervisors looked to prevent banks from repeating behaviors observed during the 2007–09 global financial crisis (GFC). During that crisis, banks continued to pay dividends to shareholders while suffering sizable losses. Ultimately, those losses left many banks teetering on the edge of failure, and a federal bailout was required to keep the system afloat.