Stress tests signal more intervention

By Tom Braithwaite in Washington

Published: May 7 2009 17:01 | Last updated: May 7 2009 20:13

The stress tests on the 19 biggest US banks pave the way for an ongoing interventionist approach to regulation, Ben Bernanke, chairman of the Federal Reserve, signalled on Thursday.

Hours before the publication of the results of the tests, which are expected to show that banks including Citigroup and Bank of America will need to raise equity, Mr Bernanke told the Chicago Fed that the “exercise has been comprehensive, rigorous, forward-looking, and highly collaborative… Undoubtedly, we can use many aspects of the exercise to improve our supervisory processes in the future.”
With the US government in the throes of a broad regulatory overhaul, Mr Bernanke said that liquidity and risk management would be subject to “equal emphasis” with capital standards, which fell short in measuring the health of the sector.

“Although capital remains a critical bulwark of a strong banking system, the crisis has also demonstrated the importance of effective liquidity management,” he said.

“Along with our colleagues at the other US banking agencies, we are monitoring the major firms’ liquidity positions on a daily basis and are discussing liquidity strategies, key market developments and liquidity risks with the firms’ senior managements.”

The stress tests are expected to show all the banks passing a benchmark Tier 1 capital ratio, but regulators believe that is no longer an appropriate measure of strength. Both the Treasury and the Fed are focusing more on tangible common equity.

Leaked information from the tests has buoyed the stock market in recent days as investors have grown increasingly confident that any capital shortfall at the most troubled institutions was not as big as feared. Shares on Thursday fell however as the results of the tests got closer.

Tim Geithner, Treasury secretary, said on Wednesday in an interview with PBS television’s Charlie Rose programme that there were “very significant cushions in these institutions today, and all Americans should be confident that these institutions are going to be viable institutions going forward”.

Mr Bernanke also signalled that pay should be reformed at banks, with bonuses set up to focus on long-term success rather than short-term profits. “Bonuses and other compensation should provide incentives for employees at all levels to behave in ways that promote the long-run health of the institution,” he said.

Copyright The Financial Times Limited 2009

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