Following the doubling of dividend and share buyback announcement by Comerica Inc. (CMA), the Federal Reserve has devised guidelines that it would follow to grant banks, that undergone stress test in 2009, the permission to increase dividends and buy back shares. 

The Fed plans to start reviewing the payout requests from the U.S. banks in the first quarter of 2011. It has laid down guidelines on which it will base its decision of approval. A Tier 1 common equity ratio of 5% needs to be maintained after any such payouts.  

Additionally, the companies must repay or replace any sort of government bailouts, either through preferred or common stock, before opting for such payouts. Moreover, they need to prove that their capital levels are sufficient to absorb losses from any adverse economic scenarios including a recession. They are also required to lay out how they would satisfy the Basel III capital norms before going for any dividend increase or buybacks.  

In fact, all the 19 banks that were subject to the stress test last year must submit their capitals plans by January 7, 2011. Even if they don't opt for either dividend increase or share buyback, they need to submit their capital plans to the Fed.  

With concerns over capital in the face of rising problematic loans, the Fed officials had asked for a reduction or elimination of dividends by banks following the decline in earnings and a deteriorating economic outlook. The new guidelines set down by the Fed are a positive indication about the economy's health and the banks' condition, and inspire our confidence in the banking system.