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Fed Wants Annual US Bank Stress Tests

Tom Braithwaite, Justin Baer HKSCKPVIamp; Patrick Jenkins, Financial Times
Tuesday, 17 May 2011 | 6:16 PM ET

The Federal Reserve wants to subject US banks to annual stress tests, reserving the right to veto dividend pay-outs if they do not pass.

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A draft of the new rule is set to be approved by the Federal Reserve Board and put out for public comment within weeks. Bank executives told the Financial Times that they have begun discussing the proposal with Fed officials, who remain wary of a return to the over-generous shareholder pay-outs that left financial institutions under-capitalised during the crisis.

Stress tests conducted by the Fed in 2009 helped rebuild confidence in the battered US financial system. In March, the central bank reviewed capital plans submitted by the country’s 19 largest lenders.

The Fed signed off on a series of dividend increases and stock buybacks from many of the biggest US banks, while prompting others — including Bank of America — to acknowledge they would have to resubmit capital plans rejected by the regulator.

"We also considered the implications of the requests for the capital available to the banking system as a whole, with the objective of ensuring that bank credit would still be available to households and businesses even if the economy were to perform more poorly than expected." -Chairman, Federal Reserve, Ben Bernanke

Enforcement of annual reviews would likely scotch bank investors’ hopes for robust dividend payments and aggressive stock buy-backs. “Banks are going to have to go back and ask for approvals for all sorts of actions, more so than in the past,” said Mike Mayo, analyst at CLSA. “Capital redeployment by the banks will be stretched out over time and won’t be under banks’ control as much as many investors thought.”

Uncertainty has shrouded banks since they raised billions of dollars in equity to repay government bailout funds. The KBW Bank Index, a benchmark for lenders’ shares, has slipped more than 6 per cent in the past year.

In between their annual reviews, banks would be able to resubmit capital plans should they wish to increase dividend payments or stock buybacks.

Ben Bernanke, Fed chairman, said this month that he expected banks to demonstrate they possessed “robust risk-management systems”, as well as capital plans allowing them “to manage potential losses in stress scenarios” and “comfortably” meet newly agreed international capital standards.

“We also considered the implications of the requests for the capital available to the banking system as a whole, with the objective of ensuring that bank credit would still be available to households and businesses even if the economy were to perform more poorly than expected,” he said.

European regulators are applying stress tests to 90 banks across the region, representing the top two-thirds of the sector.

The exercise is driven largely by a desire among European institutions, such as the European Commission and European Central Bank, to restore investor confidence in the continent’s banks, amid the eurozone’s sovereign debt crisis.

The Fed’s move is a sign that global regulators are prepared to retain tools forged in the 2008 crisis even as the financial sector gradually recovers.

Some US bank executives say the restrictions on capital distribution are excessive. But some European officials say the Fed has been too lenient in allowing US banks to step up dividends so soon after their near collapse.

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