08 May 2009

US banks stress test not so stressful

After the orchestrated leaks over the past weeks on first the methodology and then the banks that may have to raise fresh capital, no surprise: 10 banks out of 19 have are the winners and will need to raise core capital for $74.6 billion to sustain the more adverse scenario (notice not the most...).

Under the more adverse scenario (but everybody knows what worst case means after the financial meltdown we witnessed), the 19 banks could lose an additional $599 billion over 2 years vs $834 billion tier 1 capital (and only 50% of this in common capital).

I am neither Dr. Doom nor Mr. Boom, and do not know whether the assumptions are too optimistic or not (I however doubt that a central bank can be too gloomy; it has to have an optimistic bias). I only have one comment: today the US hit the 8.9% unemployment threshold in 2009 for the more adverse scenario (release of today unemployment numbers were better than economists' forecasts but in line with the ADP employment report published 2 days ago).

And what about banks beyond the 19 too big too fail?

The most interesting part of the report is the FED emphasis on core tier 1 capital. Increasingly, supervisory authorities will bear more attention to this, and probably less to all the hybrid capital or quasi-equity. My view is this will be part of a reform (if any) to be enacted by regulatory bodies. This also mean no return to over-leverage in the near future and lower Return On Equity coupled with less volatility for banks in the western hemisphere.

I recommend readers interested in the details of the stress tests per bank in a graphical and interactive way to go to the WSJ.


The Supervisory Capital Assessment Program: Overview of results
Board of Governors of the Federal Reserve System, May7, 2009