By David Benoit and Lalita Clozel 

The Federal Reserve cleared the nation's biggest banks to increase their payouts to shareholders, another sign that the industry has grown fit enough to handle a severe economic shock.

All 18 banks reviewed, a group that includes giant U.S. lenders JPMorgan Chase & Co. and Bank of America Corp., passed round two of the Federal Reserve's stress tests, an annual exercise designed to gauge banks' ability to withstand a recession. It was only the second time since the Fed began administering the exams that no bank failed.

A few banks in regulatory hot water were cleared, opening the door for a wave of dividends and stock buybacks that could boost bank stocks left behind in the market rally. This year's scenario was among the toughest yet, but a recent Fed overhaul of the test made it easier for banks to pass.

The two-stage process, introduced by the Dodd-Frank financial overhaul enacted in response to the financial crisis, first measures how the banks would fare in severe economic scenarios, including double-digit unemployment and a 50% decline in U.S. stocks. Those results, released last week, showed an industry losing a total of $410 billion but left with more capital than in the prior year's test.

For the second stage, the Fed measures how banks would fare under the same scenarios after increasing their dividends and stock buybacks. The outcome determines how much banks can return to investors and how much they have to keep socked away.

While no banks failed the second round of the test, JPMorgan Chase and Capital One Financial Corp. had to resubmit their capital-return plans to stay above the Fed's regulatory minimum capital levels.

The Fed dinged Credit Suisse Group AG over its projections for trading losses in the test and gave it four months to improve its capital-planning processes.

Under a process known as the mulligan, banks are allowed to adjust their capital-return plans and retake the test if their initial proposals would put them below the line. Banks can be more or less aggressive under that process, giving themselves a capital cushion to stay well above the thresholds or cutting it close to pay out more to shareholders.

Wells Fargo & Co., which is operating under an unprecedented growth cap imposed by the Federal Reserve following a string of scandals, passed with a wide capital cushion.

Deutsche Bank AG, which failed the test last year and was told to improve its forecasting and risk controls, also was cleared this year. The bank's U.S. operations have been under heightened scrutiny since the Fed in early 2017 downgraded the operations to "troubled condition" status, The Wall Street Journal previously reported.

Bank stocks have trailed the broader market this year on persistent concerns about the direction of interest rates and the possibility of an economic slowdown. The steady pace of rate increases in recent years has allowed banks to charge more on loans while more slowly raising the interest they pay to depositors. The KBW Bank Index is up 12% this year, compared with a 16.7% gain in the S&P 500.

Seventeen banks skipped this year's exercise under a new biennial schedule. Most of the 18 firms undergoing the test this year weren't subject to a potential failure under the qualitative review, which evaluates a firm's capital-planning analysis and internal controls.

Deutsche Bank, Credit Suisse and other foreign banks remained subject to potential failure because they were newer to the test.

The chance for a public shaming under the stress tests could soon recede even further. The Fed last year proposed eliminating the threat of failure for big banks on the numbers-based portion of the test, integrating their results instead into a continuous capital requirement.

Write to David Benoit at david.benoit@wsj.com and Lalita Clozel at lalita.clozel.@wsj.com

(END) Dow Jones Newswires

June 27, 2019 16:44 ET (20:44 GMT)

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