The Dodd-Frank Act is being scrutinized currently by banks, both large and small, as well as investors in the banking and finance sectors. Dodd-Frank Act stress testing (DFAST) is a forward-looking component conducted by the Federal Reserve and financial companies supervised by the Federal Reserve to help assess whether institutions have sufficient capital to absorb losses and support operations during adverse economic times. Sounds like a good thing. However, at the moment it is having deleterious effects on the banking industry.
The Fed is telling member banks to “show me the money” so to speak, and this uncertain regulatory environment is wreaking havoc on banks. Even as interest rates are predicted to rise this year, and as treasury yields are going higher, bank stocks are taking a swan dive. At the crux of the matter is the issue of whether the Fed will continue to accommodate dividends and stock buybacks that they have control over. With the advent of new proposed stress test requirements, backs are unsure as to what benchmarks they will have to meet to stay financially sound based on Fed capital requirements.
The big money center banks like Goldman Sachs and Morgan Stanley will certainly feel the unease, as well as all other Fed member banks. Banks as well as other corporate sectors often buyback their stock when they believe it to be undervalued in relation to their cost of capital. According to JPMorgan Chief Executive James Dimon, buybacks aren’t a great use of capital when valuations get high. Here is a look at recent share repurchases from the money center banks:
Gina Sanchez, CEO of Chantico Global, has other ideas as to why bank stocks are dropping in this rising interest rate environment. Sanchez is bullish on banks long term, but has some current issues. Tariffs, protectionism, and the flattening of the yield curve. Bank stocks are thought to fare well in rising rate environments, but as Treasury spreads fall, financial equities are taking a hit. Sanchez states that, “Banks typically reap the rewards of higher interest rates, but they appear to be bucking that trend, falling amid a widespread concern in the market around recently announced tariffs and trade war fears.” One could say this is true, but the market often has knee-jerk reactions to events in volatile times like we see now.
The Federal Reserve and Chairman Powell are stepping up its importance of late with bringing to the table a stress test that affects banking institutions with over $10 billion in assets. The Fed employs over 300 Ph.D. economists, more than anyone in the country. They are the ones assigned to make sure the banking industry doesn’t have another meltdown. In addition, the ever-present Fed ability to influence interest rates also will have a role in capital reserve requirements. In an environment where the Fed is tightening, it would seem that bank balance sheets would benefit and perhaps the stress of the stress test will be minimal.