With few months to go before the announcement of annual
Comprehensive Capital Analysis and Review (CCAR) results for
2014, U.S. banks now have a new obstacle. On Monday, the Federal
Reserve announced the independent projection of bank holding
companies' balance sheets and risk-weighted assets under the
supervisory scenarios by the agency itself. However, previous
annual reviews were based on the projections provided by each
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These balance sheet projections are used for computation of
pro-forma regulatory capital ratios under different scenarios.
According to the Fed, independent balance sheet projections
provide reliable horizontal analysis of banks. Moreover, it
enhances the comparison of results across all bank holding
companies and sustains the integrity of results as well.
After clearing stress tests, the banks have the privilege to
increase dividends and buy back shares. It is 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 criteria.
For calculation of capital ratios, a measure of shareholder
equity is divided by risk-weighted assets. Therefore, with an
increase in asset balances (all other components being equal)
banks would be required to hold more capital to keep ratios
Currently authorized under the Dodd-Frank financial services law,
the stress tests were first introduced after the 2008 financial
crisis. During this economic downturn, major financial
institutions like Lehman Brothers collapsed and several other big
banks were on the brink of failure. Such a situation compelled
the U.S. government to infuse billions of dollars into credit
markets and save the financial system.
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
taking into consideration the impact of macroeconomic and
financial market factors, which were included in the Supervisory
Stress Scenario. The banks' loans and securities portfolios,
trading as well as other causes affecting losses, revenues and
expenses were taken into count as well.
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.
Therefore, in September, several U.S. banking majors released
their mid-year stress test results as required. The results
reflected stability in the banking sector to a great extent.
Also, these reaffirmed the ability of U.S. banking giants to
survive another economic meltdown.
Notably, the mid-year stress test is different from the annual
CCAR process conducted by the Federal Reserve. This mid-cycle
stress test was performed under a hypothetical severely adverse
economic scenario assumed by the individual banks.
Wells Fargo & Company
JPMorgan Chase & Co.
Bank of America Corporation
) and The Goldman Sachs Group, Inc. (GS) were among the major
banks that released results, which stated that minimum capital
levels would remain well above regulatory requirements during the
nine-month horizon (from second-quarter 2013 through
second-quarter 2015) of high unemployment, declining home prices
and stock-market uncertainty.
U.S. banks are showing signs of improvement despite being
compelled to meet strict regulatory standards. Though it is too
early to be confident of the sector's growth prospects, the
progress seen in the first nine months of 2013 indicates a
brighter future for banks that are less dependent on risky
activities and resort to other profit-making ways.
Improved economic data such as higher consumer spending and GDP,
a rebounding housing market and declining unemployment rate raise
our hopes. However, the still low-rate environment remains a
challenge going forward.
It is impressive to see that U.S. banks are taking legal and
regulatory pressure in their stride, indicating their ability to
overcome future challenges. However, with the economy still
looking to gain traction, we do not expect the sector to return
to its pre-recession peak any time soon.