Bank ETFs In Focus On Stress Test Results, Easing Regulation

The banking corner of the financial sector has caught investors’ attention following news that regulators have eased restrictions created in the aftermath of the Great Recession. The KBW Bank Index rose 3.4% on the Jun 25 trading session with Bank of America Corp. (BAC - Free Report) and JPMorgan Chase & Co. (JPM - Free Report) leading the way.

Though the move has brought the much-needed relief to bank stocks, the stringent stance on banks’ shareholder payouts in its latest round of stress testing is expected to be a drag.

Easing of Volker Rule

FDIC officials plan to loosen the restrictions set by the Volcker Rule that will allow banks to easily make investments in various areas of venture capital. The rule change has scrapped the requirement for banks to set aside cash for derivatives trades between different affiliates of the same firm. This could free up an estimated $40 billion in capital in the banking industry, per Bloomberg. That capital could be used to bolster other parts of the business that are now stressed by the COVID-19 crisis.

The relaxation came amid lower rates and the coronavirus pandemic, which had hit the sector badly. In particular, bank stocks were beaten down on fears that the record high unemployment levels would result in surging defaults on loans.

The Volcker Rule was originally established as part of the 2010 Dodd-Frank Act, with the aim of preventing banks from acting like hedge funds and taking irresponsible risks with their investments.

Stress Test Results

The Fed stated that 33 of the nation’s largest banks are healthy, citing that all the banks appear strongly capitalized to withstand the coronavirus crisis. But the central bank said it would impose dividend caps and restriction on share buybacks in the third quarter of this year to “ensure large banks remain resilient despite the economic uncertainty from the coronavirus event.”

Big banks will be required to suspend share buybacks and cap dividend payments at their current level for the third quarter of this year. The regulator also said that it would only allow dividends to be paid based on a formula tied to a bank’s recent earnings.

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