Most Banks Well Capitalized But May Need More, Fed Says

The Federal Reserve, releasing details of how it conducted "stress tests" on the nation's 19-largest financial institutions, said "most banks" are currently well capitalized but need to hold a "substantial" amount above regulatory requirements in case the recession worsens.

“Most banks currently have capital levels well in excess of the amounts needed to be well capitalized," the Fed said in its eagerly awaited report.

The report said the tests are a “forward-looking exercise designed to estimate losses, revenues and reserve needs” under two different macroeconomic scenarios, including an adverse one.

According to the report, the "banks were asked to project their credit losses and revenues for two years."

The process "involves the projection of losses on loans, assets held in investment portfolios and trading-related exposures, as well as the firm's capacity to absorb losses in order to determine a sufficient capital level to support lending."

The government last week announced a two-stage disclosure process, wherein the test criteria would be outlined today and the actual test results on May 4.

Wall Street reaction to the report was muted in part because the Fed didn't indicate how many banks might need more capital.

"We really don’t have that many more details now, much more transparency now," said Michael Farr, president of Farr, Miller & Washington, and a CNBC contributor. Farr was critical of both the overall disclosure process and what was revealed today.

Industry reaction, however, was definitely positive. "We like it; we think it is consistent in terms of assumptions and application," said Scott Talbott, senior vice president of the Financial Services Roundtable. "At the same time, it doesn't give you the ability to be an armchair regulator and run the numbers on your own and create uncertainty in the market place."

"It certainly indicates a good faith effort on the regulators to get their arms around the conditions of the banks," said Mark Tenhundfeld of the American Bankers Association. "One of the things we were concerned about was that they would use a one-size-fits-all approach."

The tests are meant to see how the institution's balance sheets can hold up under a number of economic and financial circumstances, including a deterioration of the current recession. That would include the unemployment rate, which would lead to higher mortgage delinquencies and home foreclosures.

Economic Scenarios

The stress tests included two economic scenarios. In terms of the unemployment rate, the worse case was assumed to be 10.3 percent, housing prices are assumed to be 10 percent lower at the end of 2010 than the more likely baseline scenario. The baseline jobless rate averages 9.8 percent.