The Federal Reserve has flagged three banks in its examination of what would happen to a bank if it ran into fiscal troubles, according to data released today.
The Fed conducts the Comprehensive Capital Analysis and Review (CCAR) of 33 banks that have more than $50 billion in assets to see how the bank would react in a situation of high unemployment or a drop in the stock market.
"At its core, the test is a mathematical forecast of what would happen to a bank given certain events, such as a significant increase in unemployment or a drop in oil prices," explains the Wall Street Journal. "The banks are required to submit their tests, also called "capital plans," to the Fed. The Fed then decides whether the banks pass or fail, i.e. whether it approves or rejects the plans."
According to the report, the Fed approved of the capital plans of 30 banks, objected to two banks’ plans and asked another to resubmit their plans.
The Fed objected to the capital plans of Deutsche Bank Trust Corporation and Santander Holdings USA, Inc. because of qualitative concerns, which evaluate whether banks can accurately predict the risks they face. This is the second year both firms have failed the exams.
"Last year, the only two firms to fail the Fed exams were U.S.-based banks owned by Germany’s Deutsche Bank AG and Spain’s Banco Santander SA," explains the Wall Street Journal. "Both firms have been investing heavily in improving their risk management processes—a significant undertaking that can cost hundreds of millions of dollars."
The Fed has asked Morgan Stanley to submit a new capital plan by the end of 2016 to address its weaknesses.
"U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009," the Fed explained. "The common equity capital ratio—which compares high-quality capital to risk-weighted assets—of the 33 bank holding companies in the 2016 CCAR has more than doubled from 5.5 percent in the first quarter of 2009 to 12.2 percent in the first quarter of 2016."
"This reflects an increase of more than $700 billion in common equity capital to a total of $1.2 trillion during the same period," the Fed said.