Stress Tests: the Banks' 2016 Report Cards (June 24)

Mike & Co. —

The renewed interest in the meaning of MetLife followed word yesterday that Sen. Elizabeth Warren and other Democrats including Chris Dodd and Barney Frank submitted amicus briefs arguing in favor of the government’s appeal.  Meanwhile, the Fed announced the results of its most recent round of U.S. bank stress tests ‪Thursday, finding that the 33 banks tested have all significantly bolstered their capital defenses.

That’s good news in the face of yesterday’s Brexit vote.  Markets have reacted to the UK’s decision to leave the EU mostly through massive sell-offs as they adjust to a new normal and the US braces for any ripple effects.

More on stress tests and the continuing impact of MetLife below.

Good weekends all,

Dana

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Passing Grades All Around

The Fed looked at how the country’s 33 largest banks would do in a recession with sustained high unemployment and negative interest rates. It found that the big banks would all suffer major losses. But even with those losses, regulators said, all of the big banks would remain in relatively good financial health – and well above minimum regulatory requirements – as a result of the big cushions of shareholder money they have stockpiled in the last few years.

This is the second year in a row that all the banks undegong the tests maintained capital levels above the minimum required to pass.  That bodes well for banks as the Fed readies its assessment of their capital plans –- proposals to increase dividend payments and buy back stock.  That test, called the CCAR, is the second round of stress testing. It is seen as more important than the first; those results will be available on June 29.

Study Guide

The Fed has made sure to adjust its testing criteria each year to reflect potential economic situations based on current data.  Per a senior Fed official: “The changes we make in each year’s stress scenarios allow supervisors, investors and the public to assess the resiliency of the banking firms in different adverse economic circumstances… This feature is key to a sound stress testing regime, since the nature of possible future stress episodes is inherently uncertain.”

Thanks to that policy, the eight U.S. banks designated as “global systemically important” were required to incorporate into their stress tests a scenario where their single largest counterparty defaulted.  Additionally, six of those firms with large trading and private equity exposures — JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley — were tested on a global market shock.

Compared to last year’s test, the Fed said the most “severely adverse” scenario in this year’s examination features an even more drastic downturn in the U.S. economy.  The banks fared well despite this increased rigor, with no banks falling below the minimum required level of Tier I capital (set at 4.5 percent).

DFA’s Continuing Success

Thursday’s news drives home once again that Dodd-Frank is working as intended and has had guided America’s largest banks to a position of greater safety and security.  This contrasts with the implications of the MetLife v. FSOC case, which is being appealed by the government.

Top Democratic leaders filed an amicus brief on the case with the D.C. Circuit Court of Appeals, arguing that Judge Collier’s decision incorrectly interpreted the FSOC’s Congressional mandate to categorize financial institutions as systemically important.  According to the brief, there is no legal requirement for the FSOC to undertake a cost-benefit analysis when making its decisions.

That brief was signed by Nancy Pelosi, Harry Reid, Sherrod Brown, and Elizabeth Warren, as well as former Sen. Chris Dodd and former Rep. Barney Frank.  In total 20 current and former Democratic lawmakers signed on to the brief.

Former Fed Chairmen Ben Bernanke and Paul Volcker filed an amicus brief in support of the government as well, saying that “a major consequence” of Collyer’s decision “is that one of the world’s largest, most highly interconnected financial institutions, is left with inadequate oversight, and FSOC’s central mission of identifying and addressing future threats to financial stability is substantially undermined.”

What to Watch

The CCAR results will be made available ‪on June 29.  If those are approved then it will be a major step forward for both regulators and banks – and further proof that DFA is not only working but is advancing us toward a safer, stronger, and more resilient banking sector.