Many people are routinely tested for proficiency in their jobs, sometimes at an annual review, sometimes when obtaining renewed certification. Take a lifeguard, for example. With so many people depending on them, pools and beaches have to make sure that they can keep their heads above water. The same general principle is true of banks and financial institutions.
The Federal Reserve “promotes a safe, sound, and stable banking and financial system” by administering two yearly tests to Bank Holding Companies with at least $50 billion in consolidated assets to ensure that they “have effective capital adequacy processes and sufficient capital to absorb losses during stressful conditions.”
According to results from one of the tests, the Dodd-Frank Act supervisory stress test, some banks would drop below the surface if thrown into a sink or swim situation. According to the results, given a hypothetical financial crisis, capital ratios were badly affected within some institutions in an significant way. But even with the less than perfect results, the Fed reports that “U.S. firms have substantially increased their capital since the first set of government stress tests in 2009.” In other words, the financial system is better able to take a blow than it was at the beginning of the recession, even if individual institutions are far from perfect.
“The aggregate tier 1 common equity ratio … of the 30 bank holding companies in the 2014 CCAR has more than doubled from 5.5% in the first quarter of 2009 to 11.6% in the fourth quarter of 2013,” reports the Fed, an improvement that is “expected to continue.” What this means, in short, is that the risk to capital ratio is better than it has been in the past; i.e. investors are protected because loans of high risk are reduced, with capital to account for losses readily available.
While 31 banks in the U.S. passed the stress test fine, those failing the test included Bank of America, while others did poorly on the analysis and review of their capital plan, which had to be submitted for review. None of them failed, but BofA, Goldman Sachs, JPMorgan Chase, and Morgan Stanley had to refine or resubmit their plans with adjusted capital actions. A couple of capital plans did fail however, including Citigroup Inc., HSBC North America Holdings Inc., RBS Citizens Financial Group Inc., and Santander Holdings USA Inc.
This is, of course, not the only measure of health in our financial institutions, but it is a significant one. Yes, it shows a need for continued improvement and monitoring, but it also shows that banks have learned from the disasters of the past, which speaks to a more hopeful future should another economic downturn occur. Another area of health in the financial institutions has to do with regulation, and with the Fed itself. There are also concerns about striking the right balance between under-monitoring and hindering bank function with over regulating.
In this past year, Sen. Elizabeth Warren (D-Mass.) has pointed to what she feels has been the biggest problem with banking reform in America. “Is there a cultural problem at the New York Fed? I think the evidence suggests that there is,” she said. “With all its resources and its new authorities, is the Federal Reserve up to the task of regulating financial institutions that are so large and complex?” She suggested that the relationship between banks and the Fed in New York has become too friendly, demanding more in depth and serious examinations.
“I think our primary focus on supervision is ensuring that the bank is safe and sound, that it’s run well,” was the response of William C. Dudley, the president of the Federal Reserve Bank of New York, according to the Huffington Post. Dudley also admitted that the concept of “too-big-to-jail” is indeed a real problem, but one that’s been managed over time to reduce that power of big banks. Since then, there have been more aggressive thoughts regarding how the New York Fed should be managed, including a suggestion that the president of the N.Y. Fed be approved by Congress after nomination by the president, as is the case with other major government positions. “If that’s a place the chairman wants to go, that’s the kind of thing that maybe we can discuss,” said Sen. Sherrod Brown (D), a progressive from Ohio on the Senate Banking Committee, according to CNBC.
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