Last week, it was announced that the results of the first round of the Federal Reserve’s annual “stress tests”—which evaluate whether U.S. banks have enough capital to withstand a financial crisis—were positive: All 33 U.S. banks passed the “warm up” stress tests, signaling that they could, hypothetically, withstand an estimated $385 billion in losses should a recession occur.
But the second round of results—released just after markets closed on Wednesday—were less promising. The second part of the stress tests are closely watched by banks and investors, since passing or failing dictates whether a particular bank is allowed to increase the amount of money it returns to shareholders in the form of dividends or share buybacks. This year, the Fed failed two banks: the Deutsche Bank Trust Corporation and Santander Holdings USA. Both are subsidiaries of European banks and both failed last year as well. This marks the third consecutive year Santander has failed.
The annual Fed stress tests were created after the financial crisis as a means of evaluating whether banks have enough of a financial cushion to absorb losses if a crisis was to occur. The aim is to prevent bank failures in the future. Under Dodd-Frank reforms, banks with more than $50 billion in assets are required to submit to the Fed detailed plans for dealing with various financial risks. After a careful evaluation, regulators decide whether a bank has passed or failed.