Stress Test Results Helping Banks Acquire Private Capital

Speaking at the Federal Reserve Bank of Atlanta 2009 Financial Markets Conference on Monday, Federal Reserve Board chief Ben Bernanke expressed cautious optimism that the government “stress tests” of how the nation’s largest banks would endure a sharp downturn in the economy already appear to be helping banks gain access to private capital, a key element in economic recovery. Here are a few excerpts from Bernanke’s prepared remarks:

From Fed: The loss of confidence we have seen in some banking institutions has arisen not only because market participants expect the future loss rates on many banking assets to be high, but because they also perceive the range of uncertainty surrounding estimated loss rates as being unusually wide. The capital assessment program [stress tests] was designed to reduce this uncertainty by conducting a stringent, forward-looking assessment of prospective losses at major banking organizations. The objective was to identify the extent to which each of the 19 firms is vulnerable today to a weaker-than-expected economy in the future, and to measure how much of an additional capital buffer, if any, each firm would need to establish now to withstand the potential losses in more-adverse economic conditions.

A principal goal of the capital assessment process is to help increase confidence in the banking system. In particular, if it helps reduce uncertainty among investors regarding future losses and capital needs, and thereby improves the banking system’s access to private capital, one of the key objectives of the program will have been achieved. It will be some time before we can evaluate the success of the program on this criterion. However, the initial indications are encouraging. Each of the 10 banks requiring an additional capital buffer has pledged to have the necessary buffer in place by the November 9 deadline. Many of the banks are well ahead in finding private-sector options for increasing their common equity, and several have announced plans for new equity issues. In another positive sign, several have announced plans to issue long-term debt not guaranteed by the FDIC.

Whether the objectives of the assessment program were achieved will only be known over time. We hope that in two or three years we will be able to reflect on the banking system’s return to health with a sharply diminished reliance on government capital. More immediately, we hope and expect that the public and investors will take considerable comfort from the fact that our largest financial institutions have been evaluated in a comprehensive and rigorous fashion; and that they will, as a consequence, be required to have a capital buffer adequate to weather future losses and to supply needed credit to our economy–even if the economic downturn is more severe than is currently anticipated.

emphasis added

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