The newest stress tests for US banks produced scores that are at odds with other measures of lenders’ safety, in another sign that some institutions may be too big for regulators to understand and executives to manage.
For example, Citigroup Inc, which has been bailed out multiple times by the US government, showed up on the score sheets posted by the US Federal Reserve on Thursday as being clearly safer than JPMorgan Chase & Co.
That conclusion is at odds with the views of investors, bond analysts and credit-rating agencies, as well as when measured by a yardstick regulators themselves want to use in the future.
“At the end of the day, there is a legitimate question about the ability of regulators to fully evaluate US$2 trillion institutions because of the complexity and exposures they have,” said Fred Cannon, director of US research at Keefe, Bruyette & Woods.
The Fed report shows the latest results of the tests that began after the 2007-2009 financial crisis to determine if banks have enough capital to withstand a severe economic crisis. The Fed concluded that the banks are in “a much stronger position” than before the financial crisis in 2008.
While experts are not arguing with the fact that the banks are better capitalized now and that the system is safer than it was in the run-up to the financial crisis, some of the numbers the regulators published left analysts and bank executives groping for explanations. The test raises questions about the ability of regulators to head off the next big threat to the financial system because of the complexity of the institutions.
The results are also important as they will help the Fed decide how much capital banks can return to investors.
The report showed that Citigroup’s capital, as tracked by the Tier 1 common capital ratio, would dip to 8.3 percent during two years of hypothetical stress. JPMorgan’s would fall to 6.3 percent. Both numbers are better than the 5 percent minimum under current regulations, but they show Citigroup having a bigger cushion to weather losses.
That does not make a lot of sense to Kathleen Shanley, a bond analyst at GimmeCredit, a research service for institutional investors.
“I wouldn’t say that Citi is safer than JPMorgan, for a variety of reasons, including its track record,” Shanley said.
Citigroup has lower credit ratings than JPMorgan, and prices for credit default swaps show the market views JPMorgan as safer. Citigroup is the third-biggest US bank by assets and JPMorgan is the biggest.
A Fed spokeswoman declined to comment, as did representatives for Citigroup and JPMorgan.
Citigroup’s score came out better partly because it started the test with a better Tier 1 common ratio, 12.7 percent compared with JPMorgan’s 10.4 percent.
The starting ratios were based on the banks’ financial statements at the end of September. They were calculated based on a set of international regulations known as Basel 1, which the Fed intends to replace as inadequate with a pending new set known as Basel 3.
Under the expected Basel 3 rules, Citigroup has estimated its ratio was 8.6 percent at the end of the third quarter, about the same as the 8.4 percent JPMorgan estimated.
Among the reasons that Citigroup’s ratio will fall so much under Basel 3 from the Basel 1 level is that the new rules will not treat as favorably Citigroup’s deferred tax assets. Citigroup expects those assets to allow it to pay lower taxes on future profits because it lost so much money when the financial crisis and recession hit. Basel 3 will also reduce the benefits of stakes Citigroup has in joint ventures, such as its brokerage with Morgan Stanley.