How Did Banks and Investors Respond to the 2020 Stress Test Results?

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In June 2020, the Board of Governors of the Federal Reserve System took steps to preserve capital at large banks by capping dividend payments to shareholders and prohibiting common stock repurchases outright for some time. In doing so, supervisors looked to prevent behavior that could threaten large banks’ survival during the COVID-19 pandemic crisis.

W. Blake Marsh investigates how the announcement of the 2020 payout restrictions influenced bank capital levels and stock prices. First, he finds that surprisingly strong income growth combined with the payout restrictions raised bank capital to near record levels. Second, although payout restrictions had only a minimal effect on stock prices for most banks, the threat of increased supervisory stringency appears to have lowered stock price returns for directly affected banks and those near the supervisory threshold. His results provide justification for supervisory restrictions during times of crisis, as restrictions may have mitigated market pressure on banks to reduce capital levels.