On Thursday, the Federal Reserve released the results of its annual bank stress tests. The Fed gave a passing grade to 29 out of 30 banks, with the sole failing grade going to Zions Bancorporation (ZION) for failing to meet the 5% top tier capital threshold under some scenarios. The Fed also announced that U.S. banks were in a better position to withstand an economic downturn than they were in 2008. The stress test environment hypothesized a scenario which included a deep recession, a sharp rise in unemployment, a 50% drop in the price of stocks, and real estate prices falling to their 2001 level.
This was the fourth such stress test since 2009, and only the second conducted under the Dodd-Frank Wall Street Reform and Consumer Protection Act. According to the Federal Reserve's website, this year's test differed from those of previous years in the following ways:
- In addition to the 18 institutions that have been part of the stress tests since 2009, an additional 12 firms with assets greater than $50 billion were included this year;
- The Federal Reserve used independent projections of balance sheet and risk-weighted asset growth rather than depending on the firms' calculation for these categories as was done in prior years, improving the comparability and robustness of the results;
- The tests included an estimate of losses that could result if a financial institution's largest counterparty were to default unexpectedly. This scenario was applied to eight firms with substantial trading or custodial operations. The counterparty default scenario is part of the global trading shock, which is applied to six firms with large trading operations; and
- The Federal Reserve in this year's test began to phase in the revised capital framework approved by the Board in July 2013. The Federal Reserve calculated each firm's capital ratios in accordance with the capital requirements that will be in effect during each projected quarter.
The results are being seen as good news for the banking sector, though it is worth noting that some of the biggest banks scored lowest on in rankings. JP Morgan (JPM), Bank of America (BAC) and Morgan Stanley (MS) were all in the bottom five, whereas Discover Financial Services (DFS) and American Express (AXP) were in the top five.
For those who just want to know whether to have confidence in the banking sector, the answer, if one excludes Zion Bancorporation, is a definitive “yes.” The same is true for those wondering if banks will likely raise their dividends. For those who wish to know the details of the test, they are available online here. For those who want to know whether the Dodd-Frank Act is a good thing, I've no answer, except to suggest that it has, as of yet, neither saved the world nor doomed it.
Julian Close has been a business writer since the first day of the twenty-first century, having written for PRA International and the United Nations Department of Peacekeeping. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. He became a stockbroker in 1993, but now works for Fresh Brewed Media and uses his powers only for good. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.