In early December, two Wall Street giants, Goldman Sachs and JP Morgan Chase, finally satisfied the Federal Reserve’s stiffer requirement with improved capital plans. The banks successfully put the matter behind them by resubmitting capital plans after the regulators found “significant weaknesses” in the ones submitted in March during a stress test. “We are pleased that the Fed determined” the bank’s stress test “process improvements met their expectations,” JPMorgan’s chief executive Jamie Dimon said in a statement.
The annual stress tests, instituted by the Dodd-Frank Act of 2010 (DFA), are designed to assess the ability of the banks to withstand severe financial and economic downturns in the future and prevent a repeat of the 2008 financial crisis. It is part of the Comprehensive Capital Analysis and Review (CCAR), a regulatory tool the Federal Reserve uses to ensure that financial institutions have robust capital planning processes and adequate capital. The results would also be the basis of determining to what extent firms can distribute capital to shareholders through dividend payments and stock buybacks—an effective way to attract potential investors. When the Federal Reserve released this year’s result, it was a shock at the time. While two of the most troubled banks in the crisis, Bank of America and Citigroup got the green light without a hitch, the Fed rebuked Goldman and JPMorgan and threatened to stop them from paying out dividends and performing stock buybacks—which would further erode capital—if the identified weaknesses were not addressed.
The misgivings of the Federal Reserve highlight the growing tensions between regulators and financial institutions, as well as the government’s continued push to strengthen the bank industry. Dealing with large and complex banks, financial regulators have spent years drafting stiffer bank rules on capital. The continued efforts of the Federal Deposit Insurance Corporation (F.D.I.C.), along with the Federal Reserve and the Office of the Comptroller of the Currency, aim at strengthening the financial system and reducing the likelihood of taxpayer-financed bailouts. In addition to raising the requirements on capital as banks’ cushion to absorb huge losses, regulators also emphasize the ex post measures by adding more flesh to “single point of entry” resolution plans.
Nonetheless, the shift in rules has been criticized for missing the next big financial failures, including areas of shadow banking and short-term financing according to industry experts. The idea of “too-big-to-fail” policies and hard-to implement resolutions plans adopted by regulators is considered the same as chasing after the dogs that do not bark, i.e. the banks, rather than the ones that do, such as federally sponsored mortgage companies.