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23 May 2024

US 'stress tests' to specify extra cushion needs of largest banks

The US wants to ensure banks can withstand the economic crisis. (REUTERS)

By Reuters

US financial regulators will soon launch a series of "stress tests" to determine which of the largest US banks should get bigger capital cushions in case of a deeper recession, said a person familiar with Obama administration plans

The person, speaking on condition of anonymity, said if institutions were found to need additional capital, financial authorities would provide them with an "extra cushion of support".

Banks are expected to receive additional information about the tests in the coming week from regulators.

The largest US banks are "well capitalised" for current conditions, the source said, but the Obama administration wants to ensure they can withstand a more severe economic climate and play an important role in helping restart the flow of credit.

Initial plans for the stress tests were announced on February 10 as part of Treasury Secretary Timothy Geithner's bank stabilisation plan, but the source for the first time linked the tests to additional government support for large banks. That person did not specify what form any extra capital cushion may take.

Little is known about the form of the stress tests, but the person described them as "consistent, forward looking and conservative".

The Obama administration has tried to ease market fears the government was poised to nationalise some large banks that are struggling with losses and a lack of confidence, notably Citigroup and Bank of America.

White House spokesman Robert Gibbs said: "This administration continues to strongly believe that a privately held banking system is the correct way to go.:

That was quickly echoed by a statement from the US Treasury.

Citigroup and Bank of America have each received $45 billion (Dh165.28bn) in government capital in recent months and guarantees against losses on portfolios of illiquid mortgage assets – aid that now exceeds their market value.

With investors losing confidence in the sector as recessionary losses on real estate and commercial loans mount, analysts say the government may have to do more to prop up the largest banks. But rather than opting for a sweeping takeover, the government may act more incrementally, demanding a little more control every time Bank of America or Citigroup seeks more capital, analysts said.

Major interventions in financial institutions, such as Bear Stearns 11 months ago, American International Group in September and a second-round investment in Citigroup, occurred just after major drops in share prices made it clear they could not raise private capital.

The government "will try to do everything it can before it nationalises banks, but it may ultimately do it," said Lee Delaporte, Director of Research at Dreman Value Management, which has $10bn under management.

"The bank stocks are telling you nationalisation is going to happen," he added.

Thus far, the Treasury has put up $235bn for banks largely by purchasing only preferred shares to avoid diluting common shareholders. Under Geithner's revamp, those injections could come in the form of shares that could be converted to common equity if necessary.

The lack of detail in Geithner's bank plan, particularly about a $500bn to $1 trillion public-private fund to soak up toxic assets, has fuelled investor concerns that bank takeovers could become an option. Geithner did not specify how much would be earmarked for bank injections, which mapped out how the second $350bn of the $700bn bailout fund would be spent.