The Federal Reserve is dialing back the regulatory burden on major U.S. banks, ending its climate stress test program and rolling out a 2025 stress test scenario that analysts see as more favorable than last year's.
The shift, combined with potential adjustments to capital rules, could offer relief to big banks like Goldman Sachs Group Inc. (NYSE:GM), and Morgan Stanley (NYSE:MS), which stand to benefit the most from a more transparent regulatory framework.
Bloomberg first reported Thursday that the Fed has closed its Climate Scenario Analysis Exercise, a program that required major bank institutions and others to submit climate-related risk data. The decision marks a reversal from recent years, when regulators sought to gauge how climate risks could affect financial stability.
A More Favorable Stress Test Scenario
On Thursday, Bank of America analysts, including Ebrahim H. Poonawala, said the 2025 stress test scenario appears "broadly better" than last year's, reinforcing their confidence that capital relief is on the way.
The stress test, designed to assess banks' resilience under hypothetical economic downturns, plays a crucial role in setting capital requirements.
Compared to last year’s adverse scenario, the updated parameters include reduced market volatility, a milder GDP decline, and a smaller drop in commercial real estate prices.
“Banks should begin to see relief on regulatory capital requirements,” Bank of America wrote in its report.
The Fed's latest release provided limited details on specific methodology changes but confirmed that steps will be taken to reduce volatility in stress test results and improve transparency.
Bank of America indicates this could be a turning point, making regulatory expectations more predictable after more than a decade of post-2008 financial crisis adjustments.
Analysts at Bank of America see Goldman Sachs and Morgan Stanley as the biggest winners, given their capital markets exposure.
“While relief should be broad-based, capital markets businesses could see relatively greater relief. Buy-rated Goldman Sachs and Morgan Stanley stand to see the largest benefit, in our view,” analysts wrote.
Will Capital Relief Follow?
A crucial unanswered question is whether the Fed will implement its proposed two-year averaging of stress test results this year.
In December, the central bank announced plans to smooth out capital requirements by averaging results over two years and allowing public comment on future test scenarios. Yet, the latest release made no mention of when these changes might take effect.
Adding to the momentum for regulatory easing, Federal Reserve Governor Michelle Bowman – widely considered as a potential contender for the Fed’s Vice Chair of Supervision – said Wednesday that key capital rules should be reconsidered.
Bowman highlighted the need to review the supplementary leverage ratio and Global Systemically Important Bank surcharges, both of which impact large banks' capital buffers.
"In its current structure, [the stress test] is an opaque test hidden from public scrutiny that is used to establish variable binding capital requirements," Bowman said.
She called for greater transparency and technical improvements to enhance the test's reliability and credibility.
Market Reactions
Shares of major U.S. banks soared on Thursday, with both the Financial Select Sector SPDR Fund (NYSE:XLF) and the Invesco KBW Bank ETF (NASDAQ:KBWB) reaching fresh record highs.
Within the big six banks, Citigroup Inc. (NYSE:C), outperformed, up 3.7%, followed by JPMorgan Chase & Co. (NYSE:JPM), up 2.2%.
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