On Thursday, the Federal Reserve released the Dodd-Frank Act
supervisory stress test 2013 (DFAST 2013) results, which reflects
stability in the banking system to a great extent. Actually, this
confirms the ability of U.S. banking giants to survive under a
tremendously difficult economic scenario.
Among 18 bank holding companies which submitted their capital
plan to the Fed in Jan 2013, the auto lender, Ally Financial,
majority-owned by U.S. taxpayers, failed to meet the minimum
requirement of 5% Tier 1 common capital ratio. With 1.5% capital
ratio, Ally remains unstable, struggling with troubled mortgages
and other distressed businesses.
However, the remaining 17 banks that have capital ratio above 5%
now have the privilege to alter their capital plans within 48
hours from the time of this result release. The Fed's approval on
these banks' capital plans is expected on Mar 14.
Root of the Stress Test
Currently authorized under the Dodd-Frank financial-services law,
the stress tests were first introduced after the 2008 financial
crisis. During this economic downturn, big financial institutions
like Lehman Brothers and AIG collapsed and several other big
banks were at the verge of a collapse. Such a situation compelled
the U.S. government to infuse billions of dollars into credit
markets and save the entire financial system from failing.
The prior tests were conducted during early 2012, 2011, late 2010
and 2009. The periodic stress tests monitor the 19 banks that are
regulated by the Fed, but MetLife Inc. did not participated in
DFAST 2013 due to its ongoing process of deregistering as a bank
The environment of the last 3 rounds of stress tests along with
the latest one is quite dissimilar to the Fed's first round. The
first round, conducted when the country was teetering under
tremendous recessionary pressure, was aimed at estimating how
much the banks would lose if the economic downturn proved deeper
than expected. Since then, the stress test rounds are
precautionary measures amid an economic recovery.
The Federal Reserve's latest stress test scenario projections
include input data supplied by the 18 banks participating in
DFAST 2013 and models created by the regulatory staff and
evaluated by a group of Fed economists and analysts. These models
were developed with the intention to inculcate the impact of the
macroeconomic and financial market factors that are included in
the Supervisory Stress Scenario and distinctive factors of the
banks' loans and securities portfolios, trading as well as other
factors affecting losses, revenue and expenses.
Moreover, the Fed's stress test was conducted to find out whether
the banks have enough capital to survive another financial
crisis, including a hypothetically 12.1% unemployment rate, more
than 50% fall in stock prices, more than 20% drop in housing
prices along with an economic downturn in developing Asia.
Moreover, profound recession in the U.S., Europe and Japan was
featured along with expected trading losses of $462 billion at
the 18 bank holding companies during the 9 quarters of the
theoretical stress scenario. Further, tier 1 common capital ratio
was anticipated to fall from an actual 11.1% in the third quarter
of 2012 to 7.7% in the fourth quarter of 2014 in the hypothetical
stress scenario. The requirements in the fifth round of stress
test was tougher compared with the prior ones.
Further, as per the Dodd-Frank Act, bank holding companies
participating in the Fed's stress test rules have to conduct two
company-run stress tests each year. Moreover, they have to
publicly unveil a summary of the results of the company-run
stress tests conducted under the strictly adverse scenario given
by the Fed.
Among 18 participating banks in the stress test, smaller banks
compared to Wall Street biggies like
JPMorgan Chase & Co.
The Goldman Sachs Group, Inc.
) performed well. With 13.2% capital ratio,
The Bank of New York Mellon Corporation
) was the best performing bank.
) which failed the test last year, recorded tier 1 common capital
ratio 8.3%. Moreover, in its latest capital plan, Citi has asked
for $1.2 billion worth of share repurchases through the first
quarter of 2014 and no change in its dividend levels. The company
had no share buyback plan before and currently pays quarterly
common stock dividend of 1 cent per share.
Among other major banks,
Bank of America Corporation
Wells Fargo & Company
) with 6.8% and 7% capital ratios, respectively, fared well
compared with the prior-year test.
Further, JPMorgan held a steady capital ratio of 6.3%. However,
two major Wall Street big shots - Morgan Stanley and Goldman
recorded 5.7% and 5.8%, the lowest results above the minimum
requirement of 5%.
Recovery on the Way
This is not the final round. The big banks will have to undergo
the Fed's stress test once every year. These would help build up
the weak capital levels of banks, which are always a threat to
the economy. Also, this could ultimately translate to less
involvement of the taxpayers' money for bailing out troubled
However, the government must necessarily set some policies so
that every industry participant contributes to the overall
profitability. While the bigger banks benefited greatly from the
various programs launched by the government, many smaller banks
are trying hard to catch up.
Yet, the banking sector presented a slightly improved picture in
2012 compared to 2011. Nagging issues like depressed home prices,
loan defaults and unemployment levels are not so prominent
compared to the last few years.
Though economic uncertainty still lingers, banks are actively
responding to every legal and regulatory pressure. In fact, this
has positioned the banks well to encounter impending challenges.
As the sector is undergoing a radical structural change, it is
expected to witness headwinds in the near to mid term. But
entering the new capital regime will significantly improve the
industry's long-term stability and security.
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Nevertheless, the approval from the Federal Reserve to increase
dividend payment and accelerate share buyback program will
definitely help banks attract more investments going forward. So
it can be said the economy is on the right track to recovery.