U.S. Banks Facing Stress Test Again - Analyst Blog

The largest banks in the U.S. need to go through another round of stress tests prior to getting approval from the Federal Reserve to increase their dividends or buy back shares. In fact, all 19 banks that were subject to the stress test last year had to submit their capital plans to the Fed by last Friday, January 7.

All the 19 banks, including biggies such as Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS) would need to demonstrate that they have adequate capital to address potential losses over the next two years under stress scenarios.

The companies must repay or replace any sort of government bailouts, either through preferred or common stock, before opting for such payouts. They need to prove that their capital levels are sufficient to absorb losses from any adverse economic and financial shocks.

They are also required to lay out how they would satisfy the Basel III capital norms before going for any capital deployment. The banks had to submit their capital plans to the Fed even if they did not opt for dividend increase or share buyback.

The tests are expected to be over in the next couple of months, and it is anticipated that the Wall Street will hear the first round of dividend increases in the second quarter. However, failing the test, a bank will have to take initiatives to raise new capital to meet all Fed requirements.

Our Take

The environment of the latest round of stress tests are dissimilar with the Fed's first round in that the earlier ones conducted in 2009 estimated how much banks would lose if the economic downturn proved even deeper than expected as the country was teetering under tremendous recessionary pressure. The latest stress tests are basically a precautionary measure amid economic recovery.

The benefits of the stress tests are in fact undeniable. We believe that this test would enable reconstruction of banks' weak capital level, which threatens the economy. Ultimately, this would also result in less involvement of taxpayer money for bailing out troubled financial institutions.

With concerns over capital in the face of rising problematic loans, Fed officials had asked for a reduction or elimination of dividends by banks following the decline in earnings and a deteriorating economic outlook.

However, if most of the major banks pass the stress test and consequently get the nod from the Fed for dividend increase and share buybacks, this will serve as a positive indication about the economy's health and the banks' condition in general. It would also inspire our confidence in the banking system.  

 
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