The Federal Reserve has warned that America’s biggest banks may sustain losses of up to $700bn in a severe downturn caused by Covid-19 pandemic.
The US central bank stated it would require companies to keep money on hand to guard against the risks.
The Fed said it was barring share repurchases and limiting dividend payments until at least October.
Although situation in a banking sector have been stable so far, officials warned of a “high degree of uncertainty”.
“Today’s actions…to preserve the high levels of capital in the US banking system are an acknowledgment of both the strength of our largest banks, as well as the high degree of uncertainty we face,” said Randal Quarles, the Fed’s vice chair for supervision of the Federal Reserve’s Board of Governors.
The specified announcement emerged along with the results of the Federal Reserve’s latest annual stress tests, which were decided to hold upon the financial crisis. These tests are meant to reveal potential weakness in the financial system.
This year, the Fed added an additional analysis based on the current recession, occurred after authorities instituted lockdowns to limit Covid-19 spread.
Using a scenario where the pandemic severely impacted the US economy, the Fed looked at how the country’s 33 biggest banks would fare if unemployment rates were to climb to 19.5%.
That is higher than the record 14.7% unemployment rate the US reported in April – but about the level the Labor Department said was likely if it adjusted for discrepancies in survey data.
According to the Fed aggregate losses could amount to $700bn.
“The Board is taking action…to require the largest banks to adopt prudent measures to preserve capital in coming months,” said Mr Quarles.
Federal Reserve Governor Lael Brainard thinks that the Fed should have announced further measures given the potential losses at stake, by barring dividend payments altogether, as well as other distributions of capital.
The current shock is already more severe than anything the Fed had anticipated in its stress tests, despite past criticism that the central bank was being unrealistically gloomy, she noted.
“It is clear that recent changes in financial markets and the macroeconomic outlook could have a material impact on banks’ risk profiles and financial conditions,” she said.
“This action creates a significant risk that banks will need to raise capital or curtail credit at a challenging time.”