Once a year the Federal Reserve puts the nation’s banks on a financial treadmill. The annual physical is designed to test how strong the country’s banks are. If a bank is healthy enough, it will be allowed to increase its
Once a year the Federal Reserve puts the nation’s banks on a financial treadmill. The annual physical is designed to test how strong the country’s banks are. If a bank is healthy enough, it will be allowed to increase its payout to shareholders if it wants. A bad bill of health and the bank will be told to bulk up its balance sheet.
These stress tests are a result of the Great Recession and the attempt at bank reforms to ensure a safer, more secure financial system. Since the almost-collapse of banking, big banks have gotten bigger. Despite all the re-regulation around banks, the reliability of these stress tests as early predictors of financial sickness is untested.
Passing the stress tests is one of a two-part process. On Wednesday, the second part will be released. The capital-planning review accesses the banks ability to hand out profits and remain with a healthy financial cushion. If you own bank stocks, this will determine if a bank can pay or increase its shareholder dividend of stock buy backs. It also decides if the bank needs to raise more money (usually by selling more stock thereby diluting current shareholders) in order to improve its financial health.
Thirty banks took the tests last year. Five failed, including Citigroup. It wasn’t the financial plan the failed Citigroup; it was the failure to plan. It was Citi’s second failing grade. Its current CEO has staked his future to getting the bank’s plans approved. Citi’s reputation also hangs in the balance. It has been the problem child of finance with a reputation of too big to fail, too big to manage.
The stress tests are mathematical calculations. Financial health is earned by actions.
