As regulators took a hard look at the banking industry, they found some of the nation’s largest financial institutions better prepared than others to sustain future market shocks.
The results of so-called stress tests on Thursday, mandated by the Dodd-Frank financial overhaul law and conducted by the Federal Reserve, indicate that most banks would survive a severe recession and a crash in the markets. The tests, which measured a bank’s capital during extreme hypothetical conditions, also produced some unlikely winners.
Citigroup, for example, outperformed its rivals just one year after a poor performance embarrassed the bank. Bank of America also showed improved capital levels under stressed conditions.
Morgan Stanley and JPMorgan Chase, however, produced some of the lowest results among large Wall Street firms. The banks have significant trading operations that can rack up big losses in turbulent times. Goldman Sachs, another trading firm, also struggled under one measure of future ealth.
The test results offer an important window into the financial system four years after the banking industry teetered on the brink of collapse. Regulators liked what they saw, in general, and cheered what the improvements portend for consumers and the economy.
“The stress tests are a tool to gauge the resiliency of the financial sector,†Federal Reserve Governor Daniel K. Tarullo said in a statement. “Significant increases in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty.â€
But the tests may not fully capture some of forces and events that occur during a financial crisis. For instance, Wall Street firms may lose access to short-term loans that are critical to their survival. It’s almost impossible to project the impact of the rapid collapse of one or two large financial firms, as was seen in 2008 when Lehman Brothers and American Inte! rnational Group were melting down.
The stress tests will also prompt chatter on Wall Street, where investors will pore over the results to gauge how much money banks can likely return to their shareholders. In the aftermath of the financial crisis, regulators prevented lenders like Citigroup and Bank of America from increasing their dividends or repurchasing shares, forcing them instead to hoard capital to absorb losses.
The results come one week before the Fed makes its final decision on Wall Street’s latest plans to ramp up shareholder payouts. Behind the scenes in the coming days, the Fed will signal to each bank whether it can proceed with its most recent payout plan, submitted in January. If the Fed objects, a bank will have an opportunity to temper its proposals for dividend payments and share buybacks before releasing the plans publicly, potentially creating a tense face off with regulators.
The stress tests have already created tension between regulators and banks. The results reeal in striking detail the losses that banks will suffer under times of stress, potentially putting financial firms on the defensive. The banks have wrangled with the Fed over how to conduct the tests and how much data to release.
But regulators argue that past blowups prompted the need for the stress tests. The annual effort, the regulators say, provides a regular health check for the same banks that brought the economy to its knees just over four years ago.
Underpinning the Fed’s stress tests are some basic assumptions. The tests estimated that 18 banks sustain combined losses of $462 billion, in a period of considerable financial and economic stress in which unemployment soars, stock prices halve and house prices drop by more than 20 percent.
The tests analyze capital as a measure of health, assessing how much capital would remain at the end of 2014 once banks are subjected to hefty losses.
In a surprise, Citigroup had capital equivalent to 8.9 percent of its assets at th! e end of ! 2014, well above last year’s showing. Bank of America’s so-called tier one common capital ratio registered at 6.9 percent, also an improvement.
But Morgan Stanley’s ratio came in at 6.4 percent. JPMorgan was 6.8. While those are lower than rivals, they are still strong capital numbers after a crisis.
On one important alternative measure of capital, Goldman Sachs had a poor showing compared to its peers. Under the stressed scenario, the bank’s tier 1 leverage ratio â€" which weighs assets differently â€" would fall to a low of 3.9 percent. This could become an issue in any discussions between Goldman Sachs and the Fed about the bank’s capital plan. When regulators assess whether a bank can proceed with its capital plan, the tier 1 leverage ratio cannot fall below 3 percent.
