08 May 2009

U.S. Banking System Well Positioned to Weather Recession

Financial markets respond positively to bank “stress test” report

The Federal Reserve has issued a cautiously upbeat report about the 19 largest U.S. banks, including Bank of America.

By Phillip Kurata
Staff Writer

Washington – The U.S. government says the largest U.S. banks are strong enough to survive the recession, even if it gets worse.

This conclusion, contained in a report released May 7, “should provide considerable comfort to investors and the public,” Federal Reserve Chairman Ben Bernanke said. “Nearly all the banks that were evaluated have enough … capital to absorb the higher losses envisioned under the hypothetical adverse scenario.”

Bernanke was commenting on the Supervisory Capital Assessment Program, commonly called the bank “stress test,” which looked at how the 19 largest U.S. banks would hold up if economic conditions grew substantially worse. Those 19 banks account for two-thirds of the assets and about one-half of the loans in the U.S. banking system.

The report found that 10 of the banks collectively need $75 billion to have the financial cushions to satisfy the government’s demands for increased reserves that would withstand a possible deepening of the recession. The coffers of the other nine banks have enough in them to continue functioning even if the hypothetical scenario created by bank examiners came true. Under the scenario, joblessness would hit 10.3 percent and house prices would fall more than 22 percent. That scenario is worse than the current state of the economy, in which the jobless rate is below 9 percent.

“We are pleased with the results,” said Scott Talbott, vice president of the Financial Services Roundtable, a Washington-based association representing the biggest U.S. financial companies. “The report shows that the U.S. banks are well-capitalized and well-managed.”

Talbott said $75 billion is not a huge sum for the 10 banks to raise. He said that nine of the 10 can do so through private means such as stock conversions or selling assets. Only GMAC, the auto finance company linked to General Motors, faces the prospect of seeking further government relief funds, he said.

“The stress test will help replace the cloud of uncertainty hanging over our banking system with an unprecedented level of transparency and clarity,” Treasury Secretary Timothy Geithner said. “With better disclosure, private capital is more likely to flow into the financial system.” As for banks not subjected to the stress test, they too are being held to the same standards of solvency as the 19 largest, the secretary said.

As the media reported the cautiously upbeat assessment of the 19 banks, prices of banking stocks leaped upward along with an across-the-board surge in share prices on major U.S. stock indexes. Notably, Bank of America Corporation, deemed in the stress test to have the largest shortfall of capital, $33.9 billion, and Citigroup Inc., which needs to raise $5.5 billion in additional capital, were strong gainers on global markets after the release of the test results. The Dow Jones industrial average gained more than 100 points during the trading session May 7 before the report was released officially.

The Federal Reserve chairman said the U.S. government is prepared to provide additional capital needed to see the banking system through the downturn. Late last year, the government earmarked $700 billion to shore up the financial services sector, which was confronting the specter of imminent collapse. The full amount has not been disbursed. Talbott said it is unlikely that the Obama administration will have to return to Congress to ask for another infusion of taxpayer money to help ailing banks.

The treasury secretary issued a statement intended to instill confidence. “Americans should know that the government stands behind the banking system and that their deposits are safe,” Geithner said. He admonished the leading bankers to “work hard” to repair the loss of confidence in the banking system and regain the public’s trust. He urged the banks to expand lending to credit-worthy families and small businesses that are the key to economic growth and to demonstrate that they are reforming their compensation and risk-taking practices.

Stuart Mackintosh, the executive director of the Group of 30 economists tasked with drawing up proposals for regulatory reforms, said, “The stress test report helps re-establish confidence in the banking sector, which is a prime requirement for economic recovery. Obviously, an effort by the central bank and government to stabilize the economy has elements of political and economic calculation. On the balance, this has been a helpful exercise to instill confidence.”

Mackintosh sounded a note of caution abut the near-term economic future. “No one fully knows the full extent of the banking sector’s losses,” he said.

The Federal Reserve predicts the U.S. economy will come out of recession and resume growing toward the end of this year.

A copy of the “stress test” report (PDF, 330 K) is available on the Federal Reserve Web site.