Having witnessed improvements in the capital planning of major banks, the Federal Reserve has agreed to release them from the “qualitative” portion of annual stress test regime from 2019 onward.
The qualitative screening of banks is focused on whether they are able to determine the appropriate amount of capital required in the future. Upon failing the test, the banks had to resubmit revised capital distribution plans for approval.
Notably, qualitative objection was the area where most banks such as Deutsche Bank AG DB and Banco Santander, S.A. had faltered previously. The Fed noted that the qualitative screening will still be applicable to the U.S. subsidiaries of five foreign banks — Deutsche Bank, Credit Suisse Group AG CS, UBS Group AG UBS, Barclays Plc and Toronto-Dominion Bank.
These foreign banks are required to clear the test four times before being released, i.e. until 2020, except TD Bank, which just needs to successfully clear the current year’s stress test.
Notably, the relaxing stress test scenario comes as a respite for the remaining 13 major banks such as Goldman Sachs GS, Morgan Stanley MS, JPMorgan JPM and Citigroup C. All these stocks currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Though these firms’ operational and risk management processes would still be scrutinized, they will be asked to take corrective steps in case of shortcomings, rather than being declared failed in the annual test.
Assessing the health of large financial institutions under hypothetical stressful situations since 2009, stress tests have been an important measure to prevent further financial crisis.
However, they have long been criticized for being complex and cumbersome. Moreover, President Trump had pledged to make changes to the Dodd-Frank financial regulations at the time of elections, which he has stood up to.
Such easing of regulations coupled with the corporate tax reform and rising interest rates are likely to provide a boost to the banks’ profitability. Also, they might encourage banks to reward shareholders by enhancing the size of their capital deployment plans.
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