Would U.S. banks survive if the economy took an even deeper downturn? The Federal Reserve shed new light on how it's trying to answer that question in a report issued today on the government's bank "stress tests."
The government announced two months ago that it would conduct evaluations of the country's 19 largest banks -- which hold two-thirds of the assets and more than half of the loans in the U.S. banking system -- to determine whether they would require more capital from the federal government or elsewhere should the country's economy continue to deteriorate.
One hundred fifty federal examiners fanned out across the country over the last two months to evaluate.
In today's report, the Federal Reserve said that "most U.S. banking organizations currently have capital levels well in excess of the amounts required to be well capitalized," but also warned that losses tied to the deepening recession and market turmoil "substantially reduced the capital of some banks."
Regulators declared the overall banking system as a whole to be in good health -- news that experts say should relieve many Americans.
"I think there's a significant degree of comfort here for the everyday American," said Seamus McMahon, bank analyst at Booz & Company. "They can feel much more comfortable not only that their bank accounts are safe but that, over time, lending can pick up again."
The report did not provide stress test results for individual banks. Those are expected to be released the week of May 4.
For now, regulators are revealing the results only to the banks themselves. A senior Federal Reserve official said that the government today started a formal discussion process with the 19 banks about the preliminary results of the stress tests.
Under the tests, federal banking regulators required the banks to estimate future losses over the next two years if the economy were to worsen.
Then, on a firm-by-firm basis, regulators did "normal supervisory work," the official said, to understand how the banks' internal loss estimates matched or differed from the regulators' results and determined how much of a buffer of capital might be needed in case of declining economic conditions.
Regulators tested for losses in the biggest part of the banks' portfolios, including residential mortgages, credit cards, auto loans, student loans and commercial real estate loans. They also reviewed investment holdings -- from stocks and bonds to risky derivatives.
Regulators said that most banks will survive, but a few may not have enough of a cash cushion to ride out a hypothetical financial storm.
"Officially, they said, 'These banks have six months; go find the extra capital they need,'" McMahon said. "I would personally be astonished if the process were allowed to run that long."
In a conference call today, bank regulators made it clear that the goal is to make sure none of the big banks is allowed to fail and all of them have enough cash to ride out a more serious downturn.
Analysts said the stress tests were as much a political exercise as an economic one.
"That headline that the vast majority of the banks are okay is exactly the headline they wanted and is exactly the goal the stress-test exercise was designed to achieve," said Anne Mathias, director of research at Concept Capital.