US bank stress tests: capital ideas Premium

All major banks passed, but next the Fed judges their returns to shareholders

Maybe they should rename them the capital return tests. Or perhaps payout tests? Several years on from the financial crisis, bank investors no longer worry themselves over whether the capital cushions of large banks can withstand another financial crisis, they just want to know how much capital regulators will let banks return to shareholders. And, indeed, nearly all of the banks stress tested by the Federal Reserve had sufficient capital to withstand a hypothetical financial disaster complete with a deep recession, jump in unemployment, a halving of equity prices and a drop in home prices to levels last seen in 2001. Only Utah-based community bank Zions failed to maintain a minimum Tier 1 common capital ratio of 5 per cent to risk-weighted assets – a key variable.

Next week in round two of the tests, the Fed will approve or reject banks’ plans to return capital to shareholders. The decision is based partly on the numbers – whether banks can maintain certain levels of capital even with their proposed buybacks and dividends. (Banks’ capital plans are kept under wraps until then.) Naturally, banks whose scores on Thursday’s test approach the 5 per cent threshold raise eyebrows. At Bank of America, for example, the ratio fell as low as 6 per cent. And that compares with the bank’s forecast of 8.6 per cent in the hypothetical scenario. Morgan Stanley came in at 6.1 per cent and JPMorgan at 6.3 per cent.

But trying to wager who may receive a humiliating veto is tricky. The Fed also factors in “qualitative” measures, such as the quality of the banks’ own projections and planning process. Banks may not like effectively outsourcing an important corporate decision to Uncle Sam. But that is the price of taking taxpayers’ funds. The financial crisis may be becoming a memory but it is still not that distant.

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