Big banks pass first round of stress test

The US banking system has the financial strength to withstand an economic meltdown — and negative US interest rates — that cause losses of $ 385bn, regulators said on Thursday.

The Federal Reserve released the first-round results of its annual stress tests, which assess how well banks would cope with simulated shocks in the economy and financial markets.

Each of the 33 banks tested survived the toughest test designed by the regulator. Under the simulation, which lasts for nine quarters, stock prices drop about 50 per cent, unemployment reaches 10 per cent and gross domestic product declines sharply. For the first time the Fed also tested how bank balance sheets would cope with negative interest rates.

In this “severely adverse” scenario the capital ratio for each institution deteriorates but remains above the minimum required by regulators.

The industry’s overall so-called common equity tier one ratio — an important measure of financial strength that measures capital as a proportion of risk-weighed assets — drops from 12.3 per cent to 8.4 per cent, higher than the required level of 4.5 per cent.

Yet some would emerge from such a meltdown with significantly less capital than their peers. The weakest performers in the “severely adverse” simulation were Huntington Bancshares, which is based in Ohio, and Montreal-based BMO Financial. The scenario pushed their ratios down to 5 per cent and 5.9 per cent, respectively.

However, the tests did not incorporate banks’ plans to increase dividends and share buybacks. The first-round results feed into more consequential judgments the Fed will make next week when it rules on how much capital banks can return to shareholders.

Banks received the results on Thursday morning. Senior Fed officials said any institution seeing that its capital plan would push it below key thresholds had until Saturday to revise and resubmit its proposal.

When the next round of stress test results are published on Wednesday they will include both the original and revised plans for returning capital to investors.

Senior Fed officials said that larger, more complex institutions continued to suffer bigger forecast drops in capital ratios in adverse conditions than smaller, regional lenders.

Banks covered by the test account for more than 80 per cent of US banking assets. The global operations of domestic institutions are probed along with the US arms of foreign banks.

It is the sixth year the Fed has conducted the tests, which are designed to ensure banks can withstand the kind of shock that hit the financial system and world economy in 2008.

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