Brexit’s implications for Yellen’s Fed come with a timeline

As per the Federal Reserve’s press release, “the nation’s largest bank holding companies continue to build their capital levels and improve their credit quality, strengthening their ability to lend to households and businesses during a severe recession”.

“The changes we make in each year’s stress scenarios allow supervisors, investors, and the public to assess the resiliency of the banking firms in different adverse economic circumstances”, Governor Daniel K. Tarullo said.

In aggregate, Common Equity Tier 1 (CET1) capital ratio would fall from an actual 12.3% in the fourth quarter of 2015 to a post-stress level of 8.4% in the first quarter of 2018. So testing the largest USA financial institutions under negative interest rates is not outside the realm of possibilities. The ratio shows high-quality capital as a percentage of a bank’s total assets.

A total of 33 largest U.S. banks participated in the stress tests, and these banks would incur $385 billion of loan losses in total over a period of nine quarters under the most severe scenario, Xinhua news agency cited the central bank as saying in a statement.

The Fed said it was “carefully monitoring developments in global financial markets, in cooperation with other central banks”, after the results of Britain’s referendum on European Union membership were announced early Friday.

Big banks met the capital requirements plans as laid out by regulators, but a bigger test lies ahead next week.

Overall, big banks would suffer $US385 billion in loan losses over a period of nine quarters under the most severe scenario, the Fed said.

All the 33 participants’ under review by the Fed, with assets more than $50 billion, got a clean chit for their health in the annual stress test. The scenarios that lenders were subjected to in the central bank’s annual stress tests included a severe United Kingdom recession.

The Fed statement followed an announcement by the Group of Seven that their central banks were standing ready to use liquidity instruments if needed to counter extreme market volatility. The banks are required to calculate if they have enough financial cushion to absorb economic shocks caused by hypothetical events like soaring unemployment, falling stock prices or recession. For instance, Morgan Stanley’s own capital ratios under severe stress were higher than the U.S Federal Reserve test result, as were Wells Fargo & Co’s and BMO’s.

Banks that look marginal in DFAST may well have submitted capital plans that include the issuance of securities that would dramatically affect their capital scores. Since 2009, these firms have added more than $700 billion in common equity capital. Wells Fargo, the most valuable bank and considered to be among the strongest, now yields the most at 3.3%. Chief Executive Officer Brian Moynihan responded by allocating more than $100 million to overhaul controls and he promoted veteran human-resources executive Andrea Smith to chief administrative officer, overseeing the stress-test submission.