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Federal Reserve raises the bar on stress tests

Banks required to follow Fed projections on supervisory scenarios

The bar banks have to achieve in order to abide by next year’s stress tests is about to get higher as the Federal Reserve redefines the limits top banks need to reach to pass.  

The Fed released a letter Monday outlining the instructions for the Comprehensive Capital Analysis and Review for 2014, noting that it will now independently project bank holding company balance sheets and risk-weighted assets under the supervisory scenarios.

Under the previous system, the Fed used the projections of asset and liability balances and risk-weighted assets provided by each financial firm. Now the prudential regulator is hoping to add another level imposed by the Fed itself.

"It is about trying to keep the system solvent so the Fed does not have to save it. They want the banks to do their job and to be well capitalized ahead time," said Ron D’Vari, CEO and co-founder of NewOak Capital.

In order to comply with the stress tests, D’Vari said banks have two options: get more equity or leverage. And banks seem to be choosing leverage.

“In addition to enhancing the comparability of results across bank holding companies (BHCs), the independence of the supervisory models—including those relating to balance projections—supports the credibility of the results," the Fed letter noted.

Due to the updated guidelines, banks will have to raise more capital and follow more stringent requirements, D’Vari explained.

But ultimately, he said the banks are well positioned to raise more capital right now and most already have over 10% equity.  

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