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Sideways: Fed stress tests – prizes for all (US banks at least)

Deutsche Bank’s failure of the recent Federal Reserve stress tests drew attention, but while the regulator was happy to kick the battered European bank while it is down, this was in stark contrast to its treatment of favoured home-town players Goldman Sachs and Morgan Stanley.


Federal Reserve officials invented a brand-new grade that allowed the two firms to avoid failing the test, in the form of the ‘conditional non-objection’. The banks will be allowed to maintain their capital distributions to shareholders at the levels of recent years, despite submitting plans that would have meant that their capital ratios would have fallen below required levels under stressed conditions.

Goldman chief executive Lloyd Blankfein and his counterpart at Morgan Stanley, James Gorman, were able to declare victory of a sort, their stock prices were barely affected and they should find it easier to achieve the return on equity targets that are a key driver of their own remuneration packages.

Federal Reserve vice-chairman Randal Quarles was happy to explain that Goldman and Morgan Stanley kinda sorta passed the test, even though they technically failed, because the long-term effect of US tax cuts will outweigh the impact of the short-term impact on earnings.

“Even with one-time challenges posed by changes to the tax law, the CCAR [capital test] results demonstrate that the largest banks have strong capital levels and, after making their approved capital distributions, would retain their ability to lend even in a severe recession,” he said.

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