The Federal Reserve could tell major banks as soon as next week whether regulators' stress tests show they're healthy enough to boost stock dividends.

Banks have been eager to reduce massive capital cushions they built up as they recover from the 2007-2009 financial crisis, but regulators have been nervous about letting them chip away at these reserves.

The Federal Reserve's most recent stress tests, which apply to the 19 largest U.S. bank holding companies, are wrapping up as European regulators are doing their own fresh battery of tests. Last year's European stress tests were widely criticized for a lack of transparency and credibility.

Banks and analysts are viewing a Fed decision to allow banks to boost payments to shareholders as a signal to markets the financial crisis is behind the industry.

Let's get this mark of Cain off the banks, said Nancy Bush, an analyst with NAB Research.

Among the banks analysts said are most likely to be given the green light to boost dividends or buy back shares are US Bancorp , Wells Fargo , JPMorgan Chase and PNC Financial Services Group Inc

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The banks being stress-tested are the same group of companies the Fed tested in early 2009, in an exercise designed to shore up market confidence in their balance sheets. In guidance released in November the Fed said it planned to inform banks of their test results no later than March 21.

Analysts said the chances that the Fed will allow no banks to boost their dividend are low because that would suggest a lack of confidence in the economy and the industry that could rattle markets.

The U.S. bank industry paid out $53.9 billion in cash dividends in 2010, compared to $110.3 billion in 2007, before the crisis fully took hold. And many of the largest U.S. banks are still paying just a penny per share in dividends.

Most of the largest U.S. banks are targeting a dividend increase in 2011 or 2012 to roughly 30 percent of earnings.

The 30 percent target is below the 50 percent threshold many banks paid out during the boom years. But investors are clamoring for a return to more normal payments after dividends were slashed to a penny a share, or eliminated entirely during the financial crisis.

At Bank of America Corp's investor day on Tuesday, Chief Executive Brian Moynihan said the largest U.S. bank by assets hopes to modestly increase the dividend later this year, and is targeting a 30 percent dividend payout by 2013.

The reality is we're going to have to work up to that dividend level, he said.

Bank of America currently pays a 1 cent per share quarterly dividend. The bank cut the dividend from 64 cents per share in 2008 -- its highest payout to date -- to its current level after receiving $45 billion in U.S. government bailout aid at the height of the crisis.

ROAD TO RECOVERY

Banks not seeking permission for an increase are still required to submit capital plans as part of the Fed effort to regularly test the health of the 19 biggest institutions.

The Fed will not release results of its testing for individual banks and exactly what it will say publicly is unclear. It will be up to the banks to announce whether they have permission to increase their dividends.

The test results come as U.S. banks are showing signs of a sustained recovery. According to FDIC data, about 68 percent of U.S. banks showed year-over-year earnings growth in 2010 -- the largest percentage since 2002.

In total, U.S. banks earned $87.5 billion in 2010. While still well below the peak earnings of $145 billion in 2006, the profit reverses a $10 billion loss in 2009.

There remain concerns, however, because profits have gone up mostly due to banks setting aside less to guard against bad loans and other losses, as opposed to raising revenue from lending.

Some Democratic members of Congress wrote the Fed last month questioning why dividends should go up while some banks still benefit from government support through the Temporary Liquidity Guarantee Program set up in the crisis and while they still face problems in the housing market.

The Fed has so far been hesitant to let banks increase dividends, knowing it will be hard to ask them to scale back later.

Under the Fed's test, banks will have to show they can absorb losses over the next two years under situations where there are broad economic problems and problems specific to a company's business model.

They also will have to show that they have a plan to meet the new international capital standards in the Basel III agreement in the required timeframe. The Basel rules are being phased in over several years from 2013 to roughly triple to 7 percent the minimum core capital a bank must hold to withstand shocks and leave taxpayers off the hook in the next crisis.

The Fed said banks would be expected to repay any government funding they received before boosting dividends.

KeyCorp , Regions Financial Corp and SunTrust Banks Inc have not repaid taxpayer funds.

(Reporting by Dave Clarke and Joe Rauch; editing by Dave Zimmerman and Carol Bishopric)

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