The first part of the 2015 round of bank stress tests showed that all banks would remain above minimum required capital ratios in a crisis, although several banks, including Goldman Sachs and Morgan Stanley, would fall relatively close to the minimum.
The stress tests performed by the Federal Reserve simulate banks’ performance in a crisis scenario to determine whether they would be able to survive. The first part of the tests, released Thursday, examine how banks’ balance sheets hold up in a market crash scenario.
The results published by the Fed show that banks have decreased their reliance on borrowed funds over the past year, and have more capital to withstand losses without becoming insolvent.
“Higher capital levels at large banks increase the resiliency of our financial system,” said Federal Reserve Governor Daniel Tarullo in a statement accompanying the release of the results. “Our supervisory stress tests are designed to ensure that these banks have enough capital that they could continue to lend to American businesses and households even in a severe economic downturn.”
In the worst-case scenario, the 31 banks tested would lose a combined $490 billion over nine quarters. For those 31 banks, an aggregate main capital ratio calculated by the Fed, the Tier 1 common ratio, would drop from 11.9 percent in the third quarter of 2014 to 8.2 percent. That would still be well above the 5.5 percent the banks registered in the wake of the 2008 financial crisis.
That scenario envisions the unemployment rate shooting up to 10 percent, home prices crashing by 25 percent, the stock market collapsing nearly 60 percent, among other problems. In a new addition this year, it also would include yields on corporate bonds shooting up.
Thursday’s results do not carry any regulatory consequences, and do not necessarily indicate whether the banks will fail the stress tests. The second part of the tests, which will be released next Wednesday, will evaluate banks’ plans for issuing debt or raising capital and qualitative factors unique to their business. Banks that fail the second part cannot make dividends or other payouts to shareholders.
Thursday’s results do provide for some comparison between companies and show which companies might fall to near regulatory minimums.
Utah-based Zions Bancorporation would see one measure of capital to assets, its Tier 1 common ratio, fall from 11.9 percent today to 5.1 percent in that “severely adverse scenario,” just above the minimum 5 percent ratio. Last year, Zions was the only company projected to fall below the minimum ratio in the first part of the stress tests.
Goldman Sachs would see its total risk-based capital ratio dip to 8.1 percent. The minimum is 8 percent. Morgan Stanley, at 8.6 percent by that ratio, also would come close to other regulatory minimums.
Last year, the Fed flunked Citigroup and four U.S. units of foreign-held groups over concerns about the safety of their management practices, a result that hurt Citigroup’s share price and that its management aimed to avoid this year. Zions also failed for being projected to fall below minimum capital ratios.
The test results released Thursday showed Citigroup maintaining adequate capital levels throughout the simulated crisis, but Fed officials cautioned against extrapolating from those findings to the second part of the stress test.
“You can’t conclude anything precisely because you’ve got to know what their planned capital actions are,” a senior Federal Reserve official said Thursday. Those plans could include retiring debt or raising capital.
“It is the case that we’re seeing each year the actual capital ratios at the beginning of the test for the 31 firms and the post-stress ratios moving upward,” the senior official said. “That’s a good thing from our point of view, it’s a good thing for the financial stability of the United States.”
Banks were first informed of the stress test scenarios in October and submitted their data in early January. They were apprised of the results of the first part of the tests Thursday morning.
