The market has anxiously waited over two months. With the stress test results in, we now have our work cut out for us. Not that these findings were surprising, as the 10 banks which made the government’s “need to raise additional capital now” list are the usual suspects, such as Bank of America (BofA), Citigroup, Wells Fargo, SunTrust, Fifth Third, KeyCorp, and Capital One. They were problem banks before the tests and they continue to be. But this painfully drawn-out process has spawned four tangible benefits worth discussing.
First, the stress test results raise an important policy question: Should our largest banks, those central to our economy, be allowed to take such large risks? These results paint a clearer picture of the level of risky lending practices that many of our 19 largest banks engaged in over the last decade. The government’s assessment provides added support to the need for re-regulation in this vital industry. In the worst-case scenario, the Fed reported that these banks, which control the majority of our country’s deposits and loans, could need to raise approximately $600 billion in additional capital just to cover increased loan defaults.
Second, the stress test results show that risky bets were not just concentrated but spread over many areas, including trading and financial contracts, first and second mortgages, commercial loans, securities, and credit cards. Having more detail on the sheer scope and size of these risky bets and potential losses provides a stronger case for the need to revamp the capital standards currently applied to banks.
It also raises the question of how the Fed and other regulators might monitor the on-going level of bank risk-taking activities. Under the existing Tier 1 regulatory capital standard, almost all 19 banks pass with flying colors, yet the stress tests show a bleaker picture as the majority failed this equally important financial health test. The level of risk they are taking, should the economy weaken further, can not be supported by their current level of capital. Tests indicate that the 10 weaker banks need to raise approximately $75 billion to cushion against those losses.