The Fed Is Sending Big Banks Back to the Virtual Treadmill

The Federal Reserve is going to subject the nation’s 19 largest banks to a new round of stress tests to determine if they are healthy enough to pay dividends to their shareholders again.   The Fed plans to use a conservative approach, applied with an even hand, on the nation’s largest and most complex banks.  The tests also will determine if the Fed needs to repurchase shares or take other actions to protect the banks’ cushions against possible future losses.

The planned tests are a lower profile version of the 2009 round, when regulators determined exactly how much capital big banks needed to survive worst-case economic conditions.  According to Fed officials, those stress tests were an excellent lesson about how to regulate banks in a way the mirrors events taking place in the broader economy.  The Fed plans to apply those lessons to the new stress tests.

“We anticipate that some firms with high capital levels that have been retaining solid earnings for several quarters will be interested in increasing or resuming dividends,” said Fed Governor Daniel Tarullo.  “We will expect firms to submit convincing capital plans that demonstrate their ability to absorb losses over the next two years under an adverse economic scenario that we will specify, and still remain amply capitalized.”

Although the big banks appear to be significantly healthier than they were two years ago, several risks remain.  Other than the possibility of another economic downturn, banks face potential court challenges from investors who own mortgage-backed securities.  Some believe the banks should bear responsibility for loans that went south because they used improper procedures on these “put backs”.