The Federal Reserve released the results of its annual stress test on Thursday, with the largest financial institutions in the US showing that they could easily withstand a severe recession. All 23 institutions that were examined remained “well above” the Federal Reserve’s capital requirements during severe economic contractions. Passing the Federal Reserve’s test paves the way for banks to issue dividends and resume share buyback programs beginning June 30.

The scenario portrayed by the Federal Reserve included a 55% drawdown in US equities coupled with 10.85 unemployment, among other criteria. While the industry would return a loss of $474 billion under the circumstances, loss-cushioning capital would remain more than two times the Fed requirement. Given the severity of the economic contraction as a result of the pandemic, banks were prohibited to return capital to investors in order to preserve sufficient levels of capitalization. Those restrictions will now be lifted, according to a Fed statement.

Resumption of share buyback programs and the issuance of dividends will be welcomed by investors in the financial services sector. Financials lagged well behind broader markets during 2020, as central banks across the globe slashed interest rates and economic activity came to a near standstill. Bank stocks have outperformed in 2021, primarily benefitting from a spike in global yields as countries continue to reopen following the pandemic. Despite a recent downturn coinciding with a retreat in Treasury yields, bank outperformance reigns supreme.

S&P 500 VS. XLF YTD PERFORMANCE

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