After the release of the Dodd-Frank Act supervisory stress
test 2013 (DFAST 2013) results last week, the Federal Reserve
came up with the approval of capital plans of 14 financial
institutions out of 18 in the Comprehensive Capital Analysis and
Review (CCAR). Two banks have received approval subject to
certain conditions, while the capital plans of the other two have
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The Fed's approval of capital plans for most of the major U.S.
banks reflects stability in the banking system to a great extent.
The banks now have the privilege to increase dividends and buy
back shares. Amid concerns that banks might not have sufficient
capital to counter another financial crisis, they were asked to
submit their capital plans to the Fed. It was intimated to these
banks that payment of higher dividends will be restricted if they
fail to meet the requirement of 5% ratio of core capital to
risk-weighted assets among other requirements.
Root of the Capital Rules
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 on 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 crumbling.
Moreover, the first CCAR was conducted by the Fed in early 2011.
Notably, in Nov 2011, the Fed adopted the capital plan rule under
which bank holding companies having consolidated assets of $50
billion or more were asked to submit annual capital plans to the
Fed for review. As per the rule, banks need to include their
internal processes for evaluating capital adequacy, capital
actions including common stock issuance, dividends and share
repurchases along with premeditated capital actions over a
nine-quarter planning horizon.
The Fed'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.
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.
Wells Fargo & Company
The Bank of New York Mellon Corporation
) are among the major banks that have received clearance from the
Fed to raise their dividends or repurchase shares.
Another major bank,
Bank of America Corporation
), which pays a quarterly dividend of only a penny, received a
nod for the repurchase of up to $5.0 billion of common stock and
the redemption of approximately $5.5 billion in preferred stock.
However, BofA's capital plan did not include a dividend hike.
) which failed last year's stress test received the Fed's
approval for $1.2 billion worth of share repurchases through
first quarter 2014. This would definitely boost shareholders'
confidence. However, the company did not request a change in its
dividend levels and currently pays a quarterly common stock
dividend of 1 cent per share.
The Goldman Sachs Group Inc.
JPMorgan Chase & Co.
) received the Fed's approval for their proposed capital plans,
these two giants will need to resubmit the plan by the end of
third quarter 2013. The banks have been asked to resubmit the
capital plans considering the weaknesses recognized in their
capital planning processes.
Banks on Shaky Ground
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 was the only bank which failed
to meet the minimum requirement of 5% Tier 1 common capital
ratio. Therefore, with 1.5% capital ratio, Ally remains unstable,
struggling with troubled mortgages and other distressed
businesses and received Fed's rejection of its capital plan.
Apart from Ally,
) capital plan has also been rejected by the Fed based on certain
"qualitative" reasons. Though BB&T's proposed capital plan
was not disclosed, Fed specifies that the recent change in the
calculation of certain assets by the company will result in lower
capital ratio as compared with its prediction. Therefore,
BB&T will be resubmitting the capital plan shortly.
Recovery on the Way
This, however, is not the end. 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 a looming 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.
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. However,
entering the new capital regime will significantly improve the
industry's long-term stability and security.
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.