US: Fed sows havoc for risk managers

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A string of Fed announcements and decisions has baffled US markets and bank decision makers.

The Federal Reserve seems to have lost the plot. The handling of its announcement on the easing of bond buying was so obscure that long-dated bond yields have spiked and investors have exited bond funds at an alarming rate. Fed chairman Ben Bernanke says the Fed will stop buying assets when the jobless rate hits 7%, which he estimates will happen in the middle of next year – even though analysts predict that the figure might fall that far as soon as the fourth quarter of this year.

Add to that the latest announcement by US regulators about risk and one might wonder what is going on. In July, the Federal Reserve laid the foundation for a new capital framework for all US banks as part of an alignment with Basle III; regulators are reportedly going to raise the leverage ratio of the US banks to 6% for the largest banks only. That’s good news for the smaller banks, which have largely gone unheard during regulatory overhauls. But many of the large banks would face a capital shortfall if they were to hit 6%. The banks deemed large enough are JPMorgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street. And 6% is regarded as simply too high. Only Wells Fargo would meet the requirement. Basle III requirements are lower and therefore the US banks would be at a distinct disadvantage. It seems unbelievable that the Fed would make its own banks uncompetitive with international players, but that is the chief concern.

July also featured the mid-year stress test for the banks – on July 5, the banks were asked to submit stress tests against their own chosen criteria. Capital increases and interest rates are expected to be the focus, although the banks did submit their projections on interest rate risk earlier in the year. Quite why the Fed kept those results out of the public eye, but will be publishing the mid-year results, is baffling. There is too much confusion around what the Federal Reserve is doing and why.

How can banks manage risk when the regulators seem to be so haphazard in their decisions?