RiskCredit RiskMoody’s: Fed stress testing has bolstered US banks

Moody’s: Fed stress testing has bolstered US banks

The credit ratings agency judges that the Federal Reserve’s stress testing has strengthened both their capital cushions and their internal risk management.

The US Federal Reserve’s annual, two-part bank stress tests have spurred the largest US bank holding companies to increase capital cushions and strengthen internal risk management, according to Moody’s Investors Service.

In its newly-released report, the credit ratings agency (CRA) addresses investor questions on the impact of the Fed’s annual stress test exercise in anticipation of the upcoming 2016 results.

On June 23, the Fed will release results of the Dodd-Frank Act stress test (DFAST), which considers how well US banks could withstand an adverse economic scenario. Six days later, on 29 June, it will release the results of the Comprehensive Capital Analysis and Review (CCAR), which evaluates the banks’ capital plans, including dividends and stock repurchases, in light of their regulatory capital and evaluates the banks’ capital planning process. This year, 33 companies will undergo the test.

Moody’s said it believes CCAR now provides the effective minimum capital for US banks, noting that their higher capital buffers and more moderate dividend payouts relative to pre-crisis levels are a direct result of the heightened regulatory supervision.

“Capital requirements have been increased and the necessity to pass the Fed’s stress tests creates a new de facto capital requirement,” said Moody’s vice president Rita Sahu.

“The banks’ capital ratios are considerably higher today. Most common dividend payouts are now within the Federal Reserve’s 30% guidance, whereas prior to the crisis payouts exceeding 50% were common.”

The CRA said that the public results of the stress test underline the importance of the Fed’s annual process, which has forced banks to incorporate stress conditions when evaluating their own capital adequacy. Moody’s analysts noted that as banks repeat this annual
exercise, it has become more integrated in their risk management and capital planning processes.

“Because qualitative and/or quantitative failures can deliver a reputational hit to a bank, CCAR receives significant resource allocation and is an area of focus for banks’ management and boards,” said Sahu. “These tests provide an incentive for a bank’s management to improve processes and limit capital distributions, which can mean positive developments for creditors.”

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