US banks: stressed out
Annual reviews of resilience are still a check on bank activity
US banks are experiencing “so much winning”, as their country’s president might put it. Corporate tax cuts, rising interest rates and a lighter regulatory touch from Washington have all been big scores for Wall Street in the past 18 months. But the Federal Reserve’s stress test regime — borne of the financial crisis — remains mostly intact. The first set of results released at the end of last week showed that banks still answer to a powerful, independent authority.
All 35 banks participating demonstrated that they had enough equity capital to absorb huge losses during a “severely adverse scenario”: unemployment spiking to 10 per cent, stock values falling by 65 per cent and bond spreads ripping apart.
On the core common equity capital ratio, each firm was well ahead of the 4.5 per cent minimum. However, on another measure, the “supplementary leverage ratio” (SLR), Morgan Stanley and Goldman Sachs barely exceeded the minimum 3 per cent required.
The supplementary leverage ratio has been a continued source of controversy. It is supposed to be a simple calculation that avoids the complexity of risk-weighting bank balance sheet assets. But in years past it has tripped up the two former investment banks along with custodian banks.
Goldman Sachs and Morgan Stanley have already cautioned against drawing conclusions about how their capital return policies could be affected.
Earlier this year, the Fed modified the SLR rule in a way that would benefit a particular set of institutions, so-called trust banks. Trust banks believed that simply holding securities and cash for asset managers did not add to systemic risk and the change allowed the SLR calculation to account for that feature.
Still, the overall results showed that even after adding $800bn in capital since 2009, some banks are skating close to the edge. There is little doubt that banks at the margin are benefiting from a more benign regulatory environment — particularly smaller, regional and community banks. However, between higher capital standards and the accountability from stress testing, these institutions remain on notice. Winning a lot does not mean being undefeated.