Wall Street may get a 'wild card' from the Fed

Stress tests are getting tougher, and one analyst note cautions of a “new twist” this year.

Big banks might get dealt a "wild card" in stress tests this year from the Federal Reserve, according to an analyst report from Credit Suisse.

The Fed oversees the part of Wall Street banks' annual stress tests mandated by Congress in the wake of the global financial crisis. This year, the Fed threw in an additional challenge for banks of stress testing against negative interest rates, something that the central bank has been forced to consider as other countries' economies have adopted increasingly accommodative monetary policies.

And how banks plan for various scenarios could prove to be the wild card that trips up one or more stress tests.

Pair of aces
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"The qualitative assessment, in many respects, is the more difficult to maneuver," the Credit Suisse report Thursday said. "If there is a negative surprise in the (Comprehensive Capital Analysis and Review) results across our large and mid cap bank coverage universe, we think it would come in the form of a qualitative failure, or conditional non-objection."

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The prospect of the Fed adopting a negative interest rate policy, or NIRP, is being factored into bank stress tests despite the central bank's recent decision to increase rates. Although it is viewed and spoken of by Fed officials as an extreme measure to confront an economic downturn, other nations' central banks have adopted NIRP to stave off slow growth. The Fed's testing centers mainly on what would happen if yields on short-term Treasury bills would turn negative.

This year is the first time Wall Street banks have to factor negative interest rates into how they prepare stress tests, which makes for a bigger hurdle for them to clear. Bank advisers have helped them prepare various scenarios for negative interest rates.

Among potential moves to combat NIRP, banks could implement the negative rates on their corporate accounts — which would mean those account holders effectively pay banks, albeit slightly, to hold cash — but not on consumer accounts.

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Thanks to the Fed's 25 basis point rate hike in December 2015, Wall Street banks have been able to pad their margin, in part thanks to growing consumer deposits. But it isn't clear whether foisting NIRP on just a portion of bank customers will be enough to get them through stress tests. Even bank executives themselves don't seem certain.

"At least on the corporate side, I think we've got a pretty good handle on what negative rates mean," Citigroup CFO John Gerspach said at an industry conference in March. "The consumer side, that's a bit of a different story."