The US Federal Reserve ordered the 19 largest US banks to test their capital levels against a scenario of renewed recession with unemployment rising above 11 percent, two people with knowledge of the review said.
The banks stress-tested the performance of their loans, securities, earnings and capital against at least three possible economic outcomes as part of a broader capital-planning exercise. The banks, including some seeking to increase dividends cut during the financial crisis, submitted their plans last month. The Fed will finish its review next month.
“They’re essentially saying, ‘Before you start returning capital to shareholders, let’s make sure banks’ capital bases are strong enough to withstand a double dip scenario,’” said Jonathan Hatcher, a credit strategist specializing in banks at New York-based Jefferies Group Inc.
Regulators don’t want to see banks “come crawling back for help later,” he said.
Executives at banks such as JPMorgan Chase & Co in New York and PNC Financial Services Group Inc in Pittsburgh have asked regulators for permission to increase dividends.
The Fed has told banks that it expects dividends and share buybacks to be “conservative” and allow for “significant accretion of capital,” according to a November notice.
Some capital payout plans may rejected as “inappropriate,” the notice said.
The review “allows our supervisors to compare the progress made by each firm in developing a rigorous internal analysis of its capital needs, with its own idiosyncratic characteristics and risks, as well as to see how the firms would fare under a standardized adverse scenario developed by our economists,” US Fed Governor Daniel Tarullo said in an e-mail.
The Fed also wants banks to consider how the Dodd-Frank Act overhauling financial oversight might affect earnings and how they will meet stricter international capital guidelines, the notice said.
Banks will also have to consider how many faulty mortgages investors may ask them to take back into their portfolios. Standard & Poor’s Corp estimates mortgage buybacks could cost the industry as much as US$60 billion.
The Fed’s adverse economic scenario included a 1.5 percent decline in GDP from the fourth quarter of last year through the end of this year, said the two sources, who declined to be named because the Fed hasn’t made the details of the review public.
The scenario assumed growth resumes, with output rising 4 percent over last quarter’s level by the end of 2013. Unemployment would peak at more than 11 percent by the first quarter of next year and drop back to 9.5 percent by the end of 2013.
The tests are being overseen by a new financial-risk unit assembled by Fed Chairman Ben Bernanke and Tarullo. Known as the Large Institution Supervision Coordinating Committee (LISCC), the unit draws on the Fed’s deep bench of economists, quantitative researchers, regulatory experts and forecasters and looks at risks across the financial system.
The committee last year helped Bernanke respond to an emerging liquidity crisis faced by European banks.
“The current review of firms’ capital plans is another step forward in our approach to supervision of the largest banking organizations,” Tarullo said. “It has also served as an occasion for discussion in the LISCC of the overall state of the industry and key issues faced by banking organizations.”