U.S. Banks Dodge Regulatory Bullet

With the results of the government stress tests of the nation largest banks released it would appear that the banking system has dodged a regulatory bullet in terms of a potential need for massive new infusions of equity capital. What does this mean for the banking system and providers of technology to financial services?

The U.S. banking system has dodged a bullet. As the government has completed its stress testing of the nation's top 19 (why not 20?) institutions, the capital adequacy of a few of the nation's top banks have been called into question while many others have been deemed healthy -- for the moment. What is the significance of these tests? Government regulators have for each bank simulated baseline and worst case scenarios for further deterioration in asset quality -- the value of assets with each institution. The worst case scenario was very severe simulating economic conditions rivaling the great depression.

Regulators have drawn a line in the sand indicating which banks need additional equity capital to offset potential future devaluations in consumer, commercial or derivative assets. This is preventative medicine to ward off a future solvency crisis which would further aggravate global systemic risk, the risk of the global financial system freezing up with risk aversion. Banks need to lend to one another, lend to businesses and lend to consumers if the domestic and global economies are to turn a corner towards a return to modest growth over the next 18 months and in order for that to happen, relative stability and transparency regarding solvency risk with our largest banks is critical. Analysis, transparency and capital adequacy leads to improved market confidence.

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With the results of the government stress tests of the nation largest banks released it would appear that the banking system has dodged a regulatory bullet in terms of a potential need for massive new infusions of equity capital. What does this mean for the banking system and providers of technology to financial services?

The U.S. banking system has dodged a bullet. As the government has completed its stress testing of the nation's top 19 (why not 20?) institutions, the capital adequacy of a few of the nation's top banks have been called into question while many others have been deemed healthy -- for the moment. What is the significance of these tests? Government regulators have for each bank simulated baseline and worst case scenarios for further deterioration in asset quality -- the value of assets with each institution. The worst case scenario was very severe simulating economic conditions rivaling the great depression.

Regulators have drawn a line in the sand indicating which banks need additional equity capital to offset potential future devaluations in consumer, commercial or derivative assets. This is preventative medicine to ward off a future solvency crisis which would further aggravate global systemic risk, the risk of the global financial system freezing up with risk aversion. Banks need to lend to one another, lend to businesses and lend to consumers if the domestic and global economies are to turn a corner towards a return to modest growth over the next 18 months and in order for that to happen, relative stability and transparency regarding solvency risk with our largest banks is critical. Analysis, transparency and capital adequacy leads to improved market confidence.

The good news in these stress tests is that regulators feel that institutions will be able to raise additional equity either by re-jiggering of their capital structures by converting preferred stock or by raising additional common equity in the capital markets without the government directly infusing cash or taking equity positions in the banks.

Moving forward regulators and banks alike will have to have a greater level of transparency around capital adequacy and improve their enterprise risk and compliance practices. This should be welcome news to consulting and technology companies providing risk and capital adequacy solutions to the financial services industry. It is highly probable that an environment that includes greater level of risk management, increased transparency of capital adequacy and increased regulatory oversight will be the norm for many years to come. The expense measured in trillions to now and in the future for the near unraveling of the financial services system will be resident for the next couple of generations as it is paid off, over time, with interest of course.

The IDG News Service is a Network World affiliate.