Federal Reserve Chairman Ben Bernanke is on a mission to impress upon the financial community that the central bank’s periodic stress tests on banks have made the financial system much more resilient. To make that point clear, he contrasted the current state of banks to their tattered condition in 2009 after the financial crisis undercut their stability.
“The results of the most recent stress tests and capital planning evaluations continue to reflect improvement in banks’ condition,” Bernanke said Monday at a conference on financial stability sponsored by the Atlanta Federal Reserve Bank, covered by Bloomberg. Stress tests have not only shown the improving condition of United States financial institutions, but have actually strengthened the system, he asserted.
In the four years that have passed since the financial crisis, America’s largest financial institutions have been under intense legal and regulatory scrutiny. After the financial crisis, politicians and regulators searched for a means to repair the structural problems within the international banking system in order to ensure that a similar financial meltdown would never happen again and that taxpayers would never have to repeat the bank bailout.
Banks like Bank of America (NYSE:BAC), Citigroup (NYSE:C), and JPMorgan Chase (NYSE:JPM), which were among the 19 institutions tested, represent more than more than 70 percent of the assets in the U.S. banking system. But Bernanke is committed to forever banishing the idea that such banks are “too big to fail”…
In the stress tests, the Fed expected banks to show they have sufficient capital to continue to lend to households and businesses, while maintaining Tier 1 common equity ratios of at least 5 percent even under severely adverse conditions. For 2013, the Federal Reserve’s adverse scenario was based on a possible future economy struggling with an unemployment rate of 12 percent, a 5 percent decline in gross domestic product, and a 20 percent drop in housing and commercial real estate prices. Higher capital ensures that banks can absorb losses even in incredibly tough financial conditions.
“It is positive for the recovery that banks are also notably stronger than they were a few years ago,” he said. “The use of supervisory stress tests — a practice now codified in statute — has helped foster these gains.”
The Federal Reserve also plans to avert further strains in the banking system. Regulators “will continue to press banks to reduce further their dependence on wholesale funding, which proved highly unreliable during the crisis,” Bernanke said. “Banks of all sizes need to further strengthen their ability to identify, quantify and manage their liquidity risks.”
Financial institutions have also improved their liquidity buffer. “Banks’ holdings of cash and high-quality liquid securities have more than doubled since the end of 2007 and now total more than $2.5 trillion,” Bernanke added.
While the Dodd-Frank Act has given banks new powers to retain earnings and strengthen their buffers against losses, regulators and lawmakers — including Federal Reserve Governor Daniel Tarullo, Dallas Fed President Richard Fisher, and Democratic Senator Sherrod Brown of Ohio — are pushing for the central bank to take bigger steps to prevent banks from potential needing bailouts.
But Bernanke has maintained that “the economy is significantly stronger than it was four years ago,” even though conditions are clearly still far from where we would all like them to be.” He kept his comments regarding the United States’ overall economic health limited. Although Bernanke did note that monetary stimulus in advanced economies “is providing additional support for other countries through stronger financial markets, more exports.” When the time comes to tighten the Fed’s monetary policy, he said the central bank will use increases in the interest rate on excess reserves as its “principal tool.”
When considering the health of the financial sector, it is worth noting that the KBW Bank Index, which tracks shares of 24 large U.S. financial institutions, has risen 8.7 percent this year through Monday, compared with 9.6 percent for the Standard & Poor’s 500 Index.
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