Uncork the Moet: US Banks pass stress test

Chillax guys. All 31 major American banks have passed the Fed's stress tests, but Goldman Sachs only just scraped by.

by Adam Gale
Last Updated: 27 Mar 2015

There's a knot in your stomach. Your Gucci suit's sodden with sweat. Your hair's falling out. Unemployment's up to 10%. The markets are flooded with bad corporate debt. Property and equity prices have collapsed, and you're not sure you have enough capital to cover it...

No, the global economy hasn't plunged into recession again overnight - these are the conditions of a 'stress test' the US Federal Reserve just put its banks through. Well, the hair loss is optional...

The good news is that all of America's 31 major banks have passed the first round, something which hasn't happened since the tests began in 2009. The Fed required them to have a Tier 1 common capital ratio of at least 5%. This is essentially a measure of how much 'good' capital (so, no subprime asset bundles in sight) the bank has compared to its levels of debt, weighted for risk.

In the depths of the 2008-9 recession,  the aggregate ratio for the banks was 5.5%, but in the Fed's worst case test scenario, it only fell to 8.2%. If there is another crash, then, America's banks can probably bear the load. We're not too far behind either - all but the Co-op bank passed the Bank of England's most recent tests.

Banks have been responding to government pressure to improve their capital ratios since the crash, a difficult task given the amount they've had to pay out in fines. While this result may be encouraging, some have done better than others.

Masters of the Universe Morgan Stanley and Goldman Sachs had the lowest worst-case ratios, of 6.2% and 6.3% respectively, and there's no guarantee they or the others will pass the second stage of the tests on Wednesday.

These assess whether the banks could pay out dividends or buy back shares in the event of a crash. They also take into account 'qualitative' factors, such as the culture at the bank. Failing this test would have some fairly significant consequences, as any increases in dividend payments depend on banks passing. 

So the stress isn't over quite yet, even if things are somewhat more relaxed than they were a few years ago.

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