U.S. banks' stress tests may offer comfort in Brexit tumult

Mon Jun 27, 2016 11:29am EDT
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By Lauren Tara LaCapra

NEW YORK (Reuters) - The stress tests created for banks by U.S. regulators after the 2008 financial crisis may prove their worth this week, providing a timely message on banks' hardiness in the midst of turbulence over last week's vote by Britain to leave the European Union.

The Federal Reserve on Wednesday will release the second set of results from stress tests it has conducted annually on large banks since 2009. The tests look at how strong banks would be in an unforeseen crisis, with economies in freefall, stock markets dropping precipitously and market counterparties at risk of failure.

And while the stresses that the Fed is testing for in this case are imagined, analysts say the results should be reassuring to investors worried about banks' exposure to Brexit, an outcome that took the world and markets by surprise.

"This is a real-world test that can help demonstrate the greater resiliency of banks' balance sheets and the benefits of de-risking that, while having hurt revenue this decade, should help incrementally in times such as this and show the relative strength of U.S. banks," said CLSA bank analyst Mike Mayo.

Investors may take some comfort in the fact that the Fed's stress test scenarios are much tougher than anything the banks have so far faced as a result of Brexit.

In the standardized stress test, the results of which were released last week, the Fed's severely adverse scenario modeled for the stock market losing half its value and unemployment surging to 10 percent, among other factors. The results released on Wednesday will have stressful scenarios tailored to individual banks' business models and will also judge the quality of their planning processes.

In response to investor concerns, Goldman Sachs analysts issued a report on Monday showing how Brexit might affect earnings across the U.S. financial sector next year.

Their model included an extreme slowdown in dealmaking activity, a 20 percent decline in capital markets revenue for big banks and the Fed not raising interest rates at least until the end of 2017. Even so, the risk to big banks' bottom line was a 13 percent drop in earnings per share across the industry. The analysts noted that they only modeled this Brexit downside scenario "for illustrative purposes."   Continued...

A man walks past the Federal Reserve Bank in Washington, D.C., U.S. December 16, 2015.  REUTERS/Kevin Lamarque/File Photo