Official Statement from Washington on Stress Tests
This afternoon, the Federal Reserve and the national banking agencies released the results of the stress tests – the most comprehensive, forward looking review of our nation’s largest banks ever undertaken. These tests will help ensure that banks have a sufficient capital cushion to continue lending in a more adverse economic scenario. They will provide the transparency necessary for individuals and markets to judge the strength of the banking system.
This capital assessment is an important part, but just one part of the President’s comprehensive plan to stabilize and repair the financial system and help get credit flowing again. Over the last three months, we have put in place a series of programs to address the housing crisis, to help restart the securities markets that are critical to business and consumer lending, to catalyze small b usiness lending in particular, and to help create a market for legacy real estate related loans and thereby help clean up bank balance sheets.
Alongside these programs, we have worked to restore confidence in the banking system. The assessment announced today will help strengthen the lending capacity of banks, with greater transparency and actions to reinforce the amount of capital banks hold against the risk of future losses. Capital is critical to lending. Each dollar of capital generates up to 12 dollars of lending capacity. And each dollar of lending capacity helps businesses grow and reduces the cost of borrowing for firms and families.
* Greater disclosure will help improve confidence. Today’s results should make it easier for investors to evaluate risk and to differentiate across institutions. The stress test will help replace the cloud of uncertainty hanging over our banking system with an unprecedented level of transparency and clarity. This is important, as markets work best when they have full access to the information on which to make informed investment decisions. With better disclosure, private capital is more likely to flow into the financial system, which will accelerate the point at which banks can replace the government’s investments.
* Banks will be given a range of options to ensure they have a substantial capital cushion. Some institutions will be required to take steps to improve the quality and/or the quantity of their capital to give them a larger cushion to support future lending even if the economy performs worse than expected. These institutions have a range of options to raise capital in the private markets, including common equity offerings, asset sales and the conversion of other forms of capital into common equity. If these options are not sufficient, they can request additional capital from the government through Treasury’s Capital Assistance Program. Banks must submit a detailed capital plan to supervisors, who will consult with Treasury on the development and evaluation of the plan.
* Some banks will be able to begin to repay the government. Those institutions that do not need to raise additional capital will have the opportunity to repay the government’s existing capital investments. To do this, they will need to demonstrate that they are able to issue debt without FDIC guar antees, as some banks have already begun to do.
Going forward, in the event that financial institutions need significant government assistance in terms of the quantity or composition of capital, then in consultation with supervisors, Treasury will evaluate whether existing board and management are strong enough to restore the firm to viability without government assistance. Where Treasury does take common equity, we will seek to return the company to purely private ownership as quickly as possible, and will be guided by the basic principle that the best way to serve the interest of shareholders and taxpayers is to exert our influence only on core governance issues and not on day-by-day operations.
* This was a carefully designed, credible test. Banks supervisors app lied a historically high set of loss estimates on securities and loans, as well as a conservative view towards potential earnings that could act as a buffer against those losses. Taking into account the banking system’s existing capital and reserves, the public now has a better idea of how much capital banks will need to ensure they have sufficient capacity to continue providing credit in a more adverse economic downturn. These are estimate of potential losses and earnings that could occur in the event of a more severe recession. They are not a prediction of where the economy is headed. The results are less acute than some had expected, in part because concern about the risk of a more severe recession have diminished, market have improved, and banks, in anticipation of the release of the stress test, have acted in the last few months to increased capital.
* The banks that did not undergo the stress test will have access to capital on the same terms as the largest banks. To this end, the deadline for access to the preferred stock issued under the existing CPP has been extended for an additional six months, and Treasury will continue to examine other ways to ensure that small banks across the country can access capital so that they can continue providing credit to their communities. Supervisors will not extend the stress test to the rest of the banking system.
Our government has taken extraordinary actions to ensure the stability of our banking system because this is essential to contain the risk of a worse recession and to lay the foundation for a sustainable recovery.
With this support, and wi th the clarity provided by today’s announcement, banks should be able to get back to the business of banking. Those in leadership positions in our banks are going to have to work hard to repair the loss of confidence in the financial system and regain the public’s trust. They can do this by expanding lending to creditworthy families and small businesses that we depend on to generate economic growth. And they need to demonstrate that they are reforming compensation practices to reinforce limits on future risk taking. And this responsibility must be felt by all banks, including those that hope to be in a position to repay the government’s capital investments.
Today’s stress test results are an important step forward in the Administration’s plan to lead us on the path to economic recovery. Americans should know that the government stands behind the ba nking system and that their deposits are safe. The actions taken by Congress, the FDIC and the Federal Reserve have improved market confidence and reduced the threat of systemic risk. Mortgage rates have fallen to historic lows, home refinancing has increased significantly, credit spreads have narrowed and companies in recent weeks have found it easier to issue debt to finance new investments.
This is just a beginning, however. Even with the recent signs of stabilization in economic activity, the economic still faces significant risks and challenges. The cost of credit remains exceptionally high. We have more work to do, and recovery will take time. But we are starting to see some signs of progress toward financial repair, and we will continue to work to expand the availability of credit and improve the impact our new set of credit and lending programs.