November 22, 2011 9:02 pm
Federal Reserve launches new stress tests
By Tom Braithwaite in New York
The Federal Reserve will force the biggest US banks to model a severe eurozone recession and a US unemployment rate of 13 per cent as part of stress tests launched on Tuesday, which will culminate in public disclosure of banks’ stressed capital levels.
The second annual “comprehensive capital analysis and review” is designed to ensure that US banks are adequately capitalised to weather a worsening economic storm at home and abroad, including a peak decline of 6.9 per cent in eurozone real gross domestic product.
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Banks that do poorly on the exercise – which also judges their capital planning – will be prevented from paying out increased dividends or share buy-backs. The Fed said even for healthy banks proposed dividends of more than 30 per cent of net income would “receive particularly close scrutiny”.
Some have complained that the testing is too onerous as they cancel vacation for employees working on the modelling and prepare to wade through individual loan files to find the data required by the Fed.
The 19 biggest banks face the public disclosure of their stressed capital levels and revenues – a departure from last year’s tests when the Fed’s decision to prevent Bank of America from increasing its pay-out to shareholders was not initially made public.
The six biggest, including BofA, Goldman Sachs and Citigroup, will have to model a “global market shock”, testing their balance sheets against a scenario in which there is a deterioration of the eurozone crisis and a recession in the US.
In 2009, the Fed’s first stress tests proved a landmark moment in restoring faith in the banking system after the crisis when officials published results of their work that reassured investors. European tests have failed to achieve the same results, with concern that they were not sufficiently rigorous.
It is worries over the fallout from the worsening European economy and fragile banking system that have plagued US bank stocks this year, with shares in BofA and Morgan Stanley down by more than 60 and 50 per cent respectively and Citigroup and Goldman down by more than 40 per cent.
In response to worries that US banks will be hit hard by the deteriorating picture over the Atlantic, the Fed has broadened its tests to factor in a shock in the eurozone and Japanese and UK real gross domestic product falling by more than 4 per cent at the end of next year. The Fed emphasised the scenarios were “not forecasts”.
More than 30 banks have to participate in the tests compared with 19 in previous years, including any bank with more than $50bn in assets. But the smallest of the group have to provide less information to the Fed.
Banks have to show that their core “tier one common” equity remains above 5 per cent even under the stress scenario. Banks have to file data to the Fed by the start of January. Partial results will be published in March.
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