Big banks in US clear Fed's first stress test hurdle

WASHINGTON • Big banks cleared the first hurdle of this year's US stress tests as the Federal Reserve found all 35 lenders examined could withstand a severe economic downturn, though Goldman Sachs Group trailed the rest of Wall Street in a key measure of leverage.

The results announced on Thursday mark the third straight year that every bank exceeded the Fed's minimum capital demands, indicating the industry's increased comfort with reviews that once triggered headaches. The exams assess how much capital lenders would have left after enduring financial shocks.

The Fed started using the annual tests after the 2008 financial crisis to force lenders to bulk up their ability to weather losses. Each year, the central bank hatches different hypothetical crises, and the process has become the most important supervisory effort to emerge from the meltdown a decade ago.

"Despite a tough scenario and other factors that affected this year's test, the capital levels of the firms after the hypothetical severe global recession are higher than the actual capital levels of large banks in the years leading up to the most recent recession," Fed vice-chairman for supervision Randal Quarles said.

After years of practice and a long build-up of capital, banks have become more accustomed to the exams, making surprises that lead to poor performance less likely. The Fed has also tried to make the process more transparent - an effort that has accelerated amid President Donald Trump's deregulatory agenda.

The tests come in two parts, and Thursday's announcement disclosed the findings for the Dodd-Frank Act Street Test. This one measures how much capital each firm would have after an upheaval, but it does not come with a passing or failing grade.

For Wall Street, June 28 is the main event because that is when the Fed will reveal results from what is known as its Comprehensive Capital Analysis and Review (CCAR) - the test that quantifies the capital minimums. How banks do in that exercise determines whether they can win approval for plans to pay investors dividends and buy back stock. If lenders receive passing grades, analysts predict firms could pay out US$30 billion (S$40 billion) more to shareholders than they did last year.

Though Thursday's results are only seen as providing broad clues of how banks may do next week, and Fed officials routinely warn that this test uses very different calculations than CCAR, Wall Street analysts will probably take note of how close some firms came to falling below the minimum capital thresholds.

Lenders seek to stay above a 3 per cent level in their so-called supplementary leverage ratio, and the Fed's results show Goldman Sachs at 3.1 per cent and Morgan Stanley at 3.3 per cent. The leverage ratio assesses how reliant banks are on borrowed money to fund their operations.

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A version of this article appeared in the print edition of The Straits Times on June 23, 2018, with the headline 'Big banks in US clear Fed's first stress test hurdle'. Print Edition | Subscribe