All but four of 19 major United States banks got a green light yesterday to boost dividends and buy back shares after the Federal Reserve declared them strong enough to survive another serious recession.
JPMorgan, Wells Fargo and other large bank holding companies that passed the Fed's so-called stress tests announced they would return capital to shareholders, igniting a late-day rally on Wall Street. The Dow Jones industrial average rose 218 points and closed at its highest level since the end of 2007.
It's clearly good news the US banking system can now withstand a quite severe recession without falling over, said Douglas Elliott, a fellow at the Brookings Institution, a non-partisan policy think tank.
One notable exception was Citigroup, America's third-largest bank. It was among the companies the Fed said lacked enough capital to withstand another severe economic and financial crisis. Its stock price fell 4% in after-hours trading. The Fed announced the results after markets had closed.
The other three financial institutions that did not pass the Fed's hypothetical stress test were Ally Financial, SunTrust and MetLife.
The Fed reviewed the balance sheets of 19 bank holding companies to determine whether they could withstand a crisis that sends unemployment to 13% causes stock prices to be cut in half and lowers home prices 21% from today's levels.
For those banks that failed, the Fed can stop them from paying stock dividends or buying back their own stock. The Fed can also force them to raise money by selling additional stock or issuing debt.
After last year's stress tests, the Fed allowed some banks including JPMorgan Chase and Wells Fargo to raise their dividends because they were deemed healthier.
The Fed has conducted the stress tests each year since 2009. The Fed did not publicise the results of its tests in 2010 or 2011. The Fed released the results two days earlier than planned after JPMorgan sent out a press release saying it had passed the test.
After the first round of tests, in 2009, the Fed ordered 10 banks to raise a total of 75 billion. Bank of America alone was told to raise 34 billion.
This year's test was more rigorous, the Fed said, so it could be assured that the industry was prepared to meet more stringent international banking rules that go into effect in 2013.
The Fed said it also looked more closely at hypothetical loan losses from credit cards and mortgages. The Fed wants banks to show they could not only withstand the crisis but keep lending to Americans and businesses. Restricting lending during a crisis makes the economic toll worse.