Some good news from the Federal Reserve this week: U.S. banks seem to have enough cash on hand to weather a variety of unexpected economic calamities and downturns.
“The nation's largest bank holding companies continue to build their capital levels and improve their credit quality, strengthening their ability to lend to households and businesses during a severe recession,” say the results of supervisory stress tests announced by the Federal Reserve Board on June 23.
“Capital is important to banking organizations, the financial system, and the economy because it acts as a cushion to absorb losses and helps to ensure that losses are borne by shareholders,” a statement by the Fed added.
The most severe hypothetical scenario projected that loan losses at the 33 participating bank holding companies would total $385 billion during the nine quarters tested. The "severely adverse" scenario featured a severe global recession with the domestic unemployment rate rising five percentage points, accompanied by a heightened period of financial stress and negative yields for short-term U.S. Treasury securities.
The firms' aggregate common equity tier 1 capital ratio, which compares high-quality capital to risk-weighted assets, would fall from an actual 12.3 percent in the fourth quarter of 2015 to a minimum level of 8.4 percent in the hypothetical stress scenario. Since 2009, these firms have added more than $700 billion in common equity capital.
This is the sixth round of stress tests led by the Federal Reserve since 2009 and the fourth round required by the Dodd-Frank Act. The 33 firms tested represent more than 80 percent of domestic banking assets. The Federal Reserve uses its own independent projections of losses and incomes for each firm.
In addition to releasing results under the severely adverse hypothetical scenario, the Fed also released results from the “adverse” scenario, which features a moderate recession and mild deflation in the United States. In this scenario, the aggregate common equity capital ratio of the 33 firms fell from an actual 12.3 percent in the fourth quarter of 2015 to a minimum level of 10.5 percent.
The Dodd-Frank Act stress tests are one component of the Federal Reserve's analysis during the Comprehensive Capital Analysis and Review (CCAR), an annual exercise to evaluate the capital planning processes and capital adequacy of large bank holding companies. Additional CCAR results will be released on June 29.
“These supervisory stress test results reinforce the important role that advanced capital planning and liquidity management practices play in today’s regulatory environment,” says Will Newcomer, vice president for Wolters Kluwer’s U.S. financial risk & reporting business. “We see a continuing push by regulators encouraging banks to adopt more rigorous governance and control processes, and an increasing turn toward automation, in managing their capital requirement responsibilities.”