Stress tests aim for capital 'buffer' for banks

Sunday, April 26, 2009 at 4:13 AM Posted by Beijing News


The "stress tests" of major US banks will call for a capital buffer to help them withstand a worse-than-expected 3.3 percent economic contraction in 2009, the Federal Reserve said Friday.

Preliminary results of the tests were given to the 19 largest banking firms Friday and complete results will be made available starting May 4, according to the Federal Reserve, which released its methodology for the tests.

Fed officials said the tests would help reveal the need for additional capital from the government or private sources in case of a bleaker economic scenario than expected.

A Federal Reserve "white paper" showed the baseline forecast of a 2.0 percent decline in US output in 2009 followed by growth of 2.1 percent in 2010.

But banks would be expected to withstand a scenario in which the economy dropped 3.3 percent this year and grew only 0.5 percent in 2010.

The tests are part of an effort by President Barack Obama's administration to introduce transparency into its efforts to rescue the crippled banking sector, and will also help it evaluate how much government cash individual banks might need to return to health.

Officials declined to offer details on how results would be revealed for the leading 19 banking groups subject to the stress tests.

But the Fed document said any bank needing new capital would not be considered insolvent.

"A need for additional capital or a change in composition of capital to build a buffer under an economic scenario that is more adverse than expected is not a measure of the current solvency or viability of the firm," the Fed said.

"It is important to recognize that the assessment is a 'what if' exercise intended to help supervisors gauge the extent of additional capital needs across a range of potential economic outcomes."

The 19 firms under review collectively hold two-thirds of the assets and more than one-half of the loans in the US banking system.

The US government has already injected tens of billions of dollars into the banking system to help offset losses from the collapse in the US housing market, but it remains unclear whether banks will need more aid.

Senior Fed officials declined to speculate on what would be done in response to the test results, but argued that these were being done to ensure adequate capital in the event the economy takes a turn for the worse.

The forecasts used included the Fed's own projections as well as those of private economists and an "adverse" scenario that would included deeper declines in home prices and an unemployment rate as high as 10.3 percent.

Officials said the adverse scenario was not necessarily a worst-case scenario but was more pessimistic than most private and official projections.

Fed officials said the comprehensive tests were aimed at ensuring banks had adequate capital, especially from common stock, which is seen as better "quality" than preferred stock that requires dividends to be paid.

This has fueled speculation that the government would require banks to convert the Treasury's preferred shares to common shares, lowering dividend payments but giving the US government a greater stake in ownership.





Supinsky

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