At present, American banking giants are better positioned to
withstand an economic downturn. This was disclosed by the Federal
Reserve while releasing the Dodd-Frank Act Stress Test 2014
(DFAST 2014) results.
All the bank holding companies (BHCs) with $50 billion or more in
total consolidated assets are part of DFAST 2014. Among 30 BHCs
that submitted their capital plans to the Fed in Jan 2014,
) with Tier 1 common capital ratio of 3.5% failed to meet the
minimum requirement of 5%. Further, these 30 banks altogether
account for approximately 80% of total banking assets in the
Overall, under the most extreme stress scenario, the banks'
aggregate Tier 1 common capital ratio will decrease to 7.6% in
the first quarter of 2015 from 11.5% in the third quarter of
2013. Conversely, the ratio is significantly higher than 30
banks' actual ratio of 5.5% in the beginning of 2009.
Moreover, an extreme recession is expected to lead to $501
billion of losses. These included anticipated loan losses of $366
billion as well as $98 billion losses in trading and counterparty
at the eight banks that have substantial trading or custodial
Nevertheless, the clearance of stress test does not automatically
lead to the conclusion that the banks qualify for additional
capital deployment. The banks will have to wait till March 26 for
approval of their capital plans.
History repeated itself. In similarity to last year's stress
test, smaller banks fared better in comparison to Wall Street
JPMorgan Chase & Co.
The Goldman Sachs Group, Inc.
). With 13.3% capital ratio,
State Street Corp.
) topped the list, followed by
The Bank of New York Mellon Corp.
Discover Financial Services
), each having a ratio of 13.1%.
Notably, in its latest capital plan, Discover Financial has asked
for additional $1.6 billion worth of share repurchase through the
first quarter of 2015 and a 20% rise in its quarterly cash
dividend. Currently, the company has $2.4 billion share
repurchase authorization (remaining $1.1 billion as of Dec 31,
2013) and pays quarterly cash dividend of 20 cents per share.
Among other major banks, Goldman with 6.8% capital ratio
performed well in comparison to the 2013 stress test while
Citigroup's ratio fell to 7% from the prior-year test results.
Further, JPMorgan held a steady capital ratio of 6.3%.
Additionally, Ally Financial Inc. (majority-owned by U.S.
taxpayers) which had failed to clear the stress test last year,
recorded Tier 1 common capital ratio of 6.3%. Notably,
M&T Bank Corp.
Bank of America Corp.
) occupied the bottom three places with ratios of 5.9%, 6.0% and
2014 Stress Test Scenarios
The Fed had three stress test scenarios - baseline (based on
expectations of private economists), adverse and severely adverse
- to test the banks' capital strength under stressful situations.
These included 26 different variables such as employment and
exchange rates, the anticipated changes in GDP, economic
activity, prices, interest rates and a substantial weakness in
Further, the Fed tested the banks' balance sheet under the impact
of slowdown across economies and severe recession in the U.S.,
Europe and Japan, leading to about 50% fall in equity prices.
Other stressful circumstances comprised unemployment rate
reaching 11.25%, home prices declining nearly 25% and the U.S.
GDP decreasing 4.75%.
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
American International Group, Inc.
) collapsed and several other big banks were on the verge of
collapse. Hence, the U.S. government was compelled to infuse
billions of dollars into credit markets and save the entire
financial system from failing.
Stress tests have been annually conducted since 2009. Till last
year, 18 banks were part of it. Notably, the 2014 stress test
included 12 more banks including
), Discover Financial,
), Zions, along with certain subsidiaries of foreign banks like
BMO Financial, a unit of
Bank of Montreal
) of Canada and BBVA Compass Bancshares, held by Spain's
Banco Bilbao Vizcaya Argentaria SA
), among others.
The environment of the last 4 rounds of stress tests, along with
the latest one, is quite different from the Fed's first round.
The first round, conducted when the country was 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 a recovering economy.
Further, as per the Dodd-Frank Act, bank holding companies
participating in the Fed's stress test have to conduct two
company-run stress tests every 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.
Road to Recovery
Conducting stress tests is the Fed's way of evaluating the
overall performance of the banking sector. These tests help banks
to gear up and improve their weak capital levels, which threaten
the economy. Also, this could ultimately translate to less
involvement of taxpayers' money for the bailout of troubled
However, the government must necessarily set some policies so
that every industry participant contributes to the overall
profitability. While major banks benefited greatly from the
various programs launched by the government, that has not been
the case with many smaller banks.
However, the banking sector presented an improved picture in 2013
compared to 2012 and 2011. Lingering issues like depressed home
prices, loan defaults and unemployment levels are not so
prominent compared to the past few years.
Though economic uncertainty is still there, banks are actively
responding to every legal and regulatory measure. In fact, this
has positioned banks better to face possible challenges in the
future. As the sector is undergoing a radical structural change,
it is expected to witness headwinds in the near to mid term.
Nevertheless, the approval from the Fed to increase dividend
payouts and accelerate share buyback program will definitely help
banks attract more investments going forward. Hence, it can be
said the economy is on the track to recovery.
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