Coverage: U.S. banks pass stress test

Two non-U.S. banks, Santander and Deutsche, failed the latest round of stress tests from the Federal Reserve Board. Other banks had to alter their plans to return money to shareholders, but they still passed the test.

Tom Braithwaite, Ben McLannahan and Barney Jopson had these details in their story for The Financial Times:

The Federal Reserve has vetoed the US capital plans of Deutsche Bank and Santander in a stinging rebuke for the European banks even as US lenders got the green light to launch their biggest payouts to shareholders since the financial crisis.

US operations of Deutsche, Germany’s largest bank, and Santander, the biggest bank in Spain, were found to have serious deficiencies in capital planning and risk management, according to a senior Fed official.

The official said that any bank with chronic problems in those areas could eventually face a cease-and-desist order, compelling them to make specific changes or pay financial penalties. Santander has now failed the test — known as the Comprehensive Capital Analysis and Review (CCAR) — two years in succession; Deutsche was tested for the first time this year.

Failing the test prevents the US entities of the foreign banks from distributing capital to their parent companies and highlights the tougher attitude from the Fed towards overseas banks, which it worries it might have to support in a crisis.

But despite the pass, Peter Eavis wrote for The New York Times that Bank of America was particularly having trouble:

Bank of America’s slip-up will most likely raise new questions about its ability to comply with new regulations that are intended to make the financial system safer. Bank of America passed the stress test last year and gained approval for its plan to make payouts to shareholders. But a few weeks after passing, the bank discovered errors that had led it to overstate its capital by $4 billion. The mistakes prompted the Fed to tell the bank to suspend its share buybacks and an increase in its dividend.

The Fed said that Bank of America stumbled this year because it had shown weaknesses in its internal controls and in how it had projected losses and revenue in the tests. Speaking in a call with reporters on Wednesday, a senior Fed official said that Bank of America’s inadequacies were somewhat limited, which allowed the bank to avoid failing the so-called stress tests.

Bank of America found out on Wednesday that the Fed had given it only a provisional pass, according to a person briefed on the matter who spoke on the condition of anonymity.

Shelly Banjo wrote for Quartz that the tests seem to be making the banking system safer as bank hold me capital against their loan books:

At the heart of this annual exercise is the Fed’s effort to induce banks to operate using less borrowed money and rely more on their own capital. If given their druthers, banks prefer to use borrowed money—leverage—to invest, as it has the power to amplify positive returns. Unfortunately, leverage also amplifies losses. And excessive leverage was a major factor in the financial crisis, helping to create the need for a US government bailout of, effectively, the entire financial sector.

There are signs the system is safer today. Metrics show bank capital levels are much higher than they were before the crisis.

And while a safer banking system is undoubtedly good. That’s not the end of the story. Some argue that the very regulation that is improving the safety of banks is also pushing risky behavior out of the regulated system altogether. Such so-called “shadow banking” was also a source of financial instability during the crisis. And it remains quite a large part of the financial system, according to a recent report from Goldman Sachs analysts.

But not all firms are looking to stay in the business. Ted Mann wrote for The Wall Street Journal that General Electric was making cuts in its banking unit:

General Electric Co. is considering making deeper cuts in its massive banking business, deciding that the company’s returns from lending aren’t worth the discontent the business causes among GE’s investors, according to people familiar with the matter.

That assessment marks a subtle, but important, shift in GE’s thinking.

While the company has committed to shrinking GE Capital in the wake of the financial crisis, it has viewed a smaller, safer banking business as an integral part of a conglomerate better known for its jet engines, power turbines and CT scanners.

Now, GE regards the bulk of the lending operation as expendable, the people said, much the way the company viewed its appliances business, which it agreed to sell to Sweden’s Electrolux AB last year.

GE has made clear it plans to continue such pursuits as aircraft leasing and energy and health-care financing, which support its industrial operations.

Banking has undergone huge changes in the past seven years since the financial crisis. Some argue that not much is different, but regulators and other observers seem to think that the higher capital requirements have made the system safer. But no one is talking about the economic assumptions of the stress tests and if those have been updated.