US bank stress tests at odds with reality

NEW YORK: The newest stress tests for US banks produced scores that are at odds with other measures of lenders' safety, in another sign that some institutions may be too big for regulators to understand and executives to manage.

For example, Citigroup Inc , which has been bailed out multiple times by the US government, showed up on the score sheets posted by the US Federal Reserve on Thursday as being safer than JPMorgan Chase.

That conclusion is at odds with the views of investors, bond analysts and credit-rating agencies, as well as when measured by a yardstick regulators themselves want to use in the future.

"At the end of the day, there is a legitimate question about the ability of regulators to fully evaluate US$2 trillion (RM6.21 trillion) institutions because of the complexity and exposures they have," said Fred Cannon, director of US research at Keefe, Bruyette & Woods.

On Thursday, the US Fed reported the latest results of the tests that began after the 2007-2009 financial crisis to determine if banks have enough capital to withstand a severe economic crisis.

The US Fed concluded that the banks are in "a much stronger position" than before the financial crisis in 2008.

While experts are not arguing with the fact that the banks are better capitalised now and that the system is safer than it was in the run-up to the financial crisis, some of the numbers the regulators published left analysts and bank executives groping for explanations.

The report showed that Citigroup's capital, as tracked by the Tier 1 common capital ratio, would dip to 8.3 per cent during two years of hypothetical stress.

JPMorgan's would fall to 6.3 per cent. Both numbers are better than the five per cent minimum under current regulations, but they show Citigroup having a bigger cushion to weather losses.

That does not make a lot of sense to Kathleen Shanley, a bond analyst at GimmeCredit, a research service for institutional investors.

"I wouldn't say that Citi is safer than JPMorgan, for a variety of reasons, including its track record," Shanley said.

Citigroup has lower credit ratings than JPMorgan, and prices for credit default swaps show the market views JPMorgan as safer.

Citigroup's score came out better partly because it started the test with a better Tier 1 common ratio, 12.7 per cent compared with JPMorgan's 10.4 per cent.

The starting ratios were based on the banks' financial statements at the end of September.

They were calculated based on a set of international regulations known as Basel 1, which the US Federal Reserve intends to replace as inadequate with a pending new set known as Basel 3.

The Fed's scoring is also at odds with results some of the banks calculated for themselves under the same scenarios, which shows there is room for subjectivity in the testing. Reuters