Stress Test Results

US officials have made public the result of the stress test of banks.

We provide here a summary of the main points:

Scope
Major Bank Holding Companies (BHC) - 19 in total. Those BHCs hold two thirds of assets and half of loans in the US banking system.

Objective
In an "adverse scenario", each BHC should have by 2010 a tier 1 capital ratio in excess of 6% and tier 1 common capital ratio in excess of 4%. Banks who don't satisfy both ratios will need to raise more capital to reach it.

Results
BHC have since the beginning of the financial crisis in 2007 lost $350 billion up to 31 Dec 2008. The stress test shows that further losses of $600 billion ($450 billion from loans and $135 billion from trading and securities) may occur within two years in the "adverse scenario", making the total losses reach $950 billion. In order to absorb such losses and keep the tier 1 ratios above the objective limit, BHCs will need to increase their tier 1 capital by $185 billion. More precisely, 10 out of the 19 BHCs will need to increase their capital and this shortfall falls exclusively in the "tier 1 common capital" category. The calculation has been done for the date of 31 Dec 2008 and some BHCs have already raised or contracted to raise capital since then, so the additional top up required falls down to $75 billion. The worst hit BHC is Bank of America whose share is $33.9 billion.

Conclusion
We can come to several conclusions regarding this exercise.
1. Most of the losses and writedowns are still to come. We have only seen 1/3 so far. This justifies in itself the exercise.
2. Banks have just enough capital to absorb the possible losses but need more in order to have a buffer necessary to keep confidence, have a prudent risk management and carry on lending at the normal pace.
3. The additional required capital, $75 billion, shouldn't be difficult to collect from private investors.
4. The stimulus package and the federal banks lending facilities (TARP) are of the same magnitude ($700 billion each) as the possible losses from the banks ($950 billion), which means that it was "rightly" calibrated.
5. It is the first time that the US government is ahead of the game.

Overall, this stress test has proved an excellent risk management exercise and the decisions will be carried through. We hope that other regions like Europe will follow the lead in organising their own stress test.

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