Term Sheet

The latest on private equity, M&A, deals and movements — from Wall Street to Silicon Valley

Stress test results: Banks could lose nearly half a trillion dollars

March 7, 2013: 4:32 PM ET

Federal Reserve says 17 of the nation's 18 largest banks could survive a severe economic meltdown.

Federal ReserveFORTUNE -- In its annual stress test of the nation's largest banks, the Federal Reserve estimated that these firms would lose $462 billion dollars if the economy were to enter another recession similar to the one we just had.

Despite those losses, though, the Fed says nearly all of these banks would survive.

Of the 18 banks tested by the Fed, only Ally Financial, the former finance arm of General Motors (GM), would sustain big enough losses to potentially put it out of business. All of the other banks would have enough capital to make it through.

But the Fed found that a key ratio of financial health for Goldman Sachs (GS) and Morgan Stanley (MS) would drop to a level that is only slightly above what the Fed considers acceptable.

MORE: Fed's stress test not stressful enough

Another surprise? Citigroup (C), which has struggled since the financial crisis and recently named a new CEO, was deemed the most prepared to weather another recession among the nation's six largest banks. Citi was followed by Wells Fargo (WFC) and Bank of America (BAC).

JPMorgan Chase (JPM), which is generally thought to be the strongest of the nation's big banks, came out only ahead of Goldman and Morgan Stanley. It also was projected to have the biggest losses of the 18 biggest banks ... at just over $77 billion.

Still, the Fed said the government bailout of the financial sector and other measures taken by the banks themselves have made them significantly better prepared for a downturn than they were before the financial crisis.

The Fed did its stress test by looking at how much the banks could stand to lose in their loan portfolios and trading books under an adverse economic scenario. The scenario included a rise in the unemployment rate to 12%, a 50% drop in the Dow Jones industrial average and a 21% drop in housing prices.

MORE: Mitt Romney returns to private equity

After estimating those losses, the Fed then figured how much capital a bank would have left as a percentage of its remaining loans and investments. The Fed generally deems a bank healthy if it has enough capital to cover a 5% drop in its assets. At the worst of the financial crisis, the average so-called capital ratio at the largest banks dropped to 5.6%. But the Fed said the average capital ratios of the big banks would only dip to 7.4% in its most recent stress test.

"Significant increases in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty," said Federal Reserve governor Daniel Tarullo in a release about the stress test.

The release of the results is only the beginning. Next week, the Fed will announce whether or not to approve plans by big banks to increase dividends and buy back more stock.

Join the Conversation
About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

Email | @stephengandel | RSS
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.