Fed expanding capital tests for U.S. banks

By Dave Clarke

WASHINGTON (Reuters) – The Federal Reserve will subject more banks to annual stress tests to determine whether they have enough capital and can raise their dividends.

On Friday, the Fed said it is proposing that banks with $50 billion or more in assets be subjected to the capital testing regime, bringing the number of banks that would face annual tests to 35 from its prior level of 19.

The tests seek to determine how a large bank whose failure could hurt the economy and markets would weather a financial shock or an economic downturn.

“Institutions would be expected to have credible plans to have sufficient capital so that they can continue to lend to households and businesses, even under adverse conditions,” the Fed said in a release.

Bank stocks, already under pressure, fell almost 2 percent midday trading Friday, as measured by the KBW Bank Index of large-cap financials. Some of the biggest decliners were regional bank stocks that are now going to face annual tests.

The test have real consequences for banks and their investors.

Following the end of the latest review in March, banks such as JPMorgan Chase & Co and Wells Fargo & Co were able to announce plans to boost their dividends, while Bank of America Corp was not.

“It’s an incremental negative that makes it easier to be negative and sell any financial stocks right now,” Michael James, a senior trader at regional investment bank Wedbush Morgan in Los Angeles, said in reference to the Fed proposal. ”The financial stocks have been a big weight and an uderperformer all year so the path of least resistance in the financials continues to be lower and this won’t help that.”

During the 2007-2009 financial crisis, the government was forced to extend substantial support to banks such as Citigroup Inc and the tests are one of several measures taken by regulators to guard against future bailouts.

The new Dodd-Frank law requires a set of stress tests for banks, some performed by banks and others directly by regulators, to ensure they can survive a steep downturn in financial markets.

The Fed said the expanded capital tests are intended to complement the stress tests required by Dodd-Frank.

The amount of information banks would have to provide the Fed for the capital tests would depend on the size and complexity of the institution, the Fed said.

The rule is expected to be finalized later this year and the new round of reviews are planned for early 2012.

The proposal will be out for comment through Aug. 5. (Reporting by Dave Clarke in Washington and Dan Wilchins in New York; editing by Dave Zimmerman and Andre Grenon)