Stress-test results raise questions: Here are answers

— -- Regulators' ambitious stress tests of the nation's 19 largest bank holding companies are finally finished. But the results, while addressing some concerns about the industry's health, are reviving old questions. And they're raising new questions.

Q: What's the significance of the stress tests?

A: The stress tests measure banks' and the industry's financial health if the economy severely worsens. The results — showing that 10 of the nation's largest banks will need to raise capital, while nine will not — "will help replace the cloud of uncertainty hanging over our banking system," Treasury Secretary Timothy Geithner said Thursday.

Regulators hope that the more information investors have about banks' financial conditions, the easier it will be for the industry to raise private capital. This, in turn, will allow banks to resume lending to consumers and small businesses, easing the credit crunch that has afflicted the nation.

Q: Were the tests strenuous enough?

A: The tests represent the government's best guess about banks' fiscal condition and their future capital needs. But they don't give a definitive clean bill of health. Some critics say that regulators should have designed a tougher test, which would have shown that the nation's 19 largest banks need significantly more capital than $75 billion.

For instance, regulators estimated banks' capital needs based on their risk-weighted assets, a measure generally favorable to banks because it allows them to hold less capital against assets considered less risky. But this "is not as stringent as other capital measures," says Joshua Rosner, managing director of Graham Fisher & Co., an independent research firm. "To use the risk weightings is fallacious, because the risk weightings are what suggested that there was no risk in residential mortgages."

Q: What do the results mean for the recovery of lending — and for the economy?

A: Economic recovery largely hinges on banks lending to consumers and businesses, which in turn, will boost spending and jump-start the economy. But economic recovery also depends on investors' perception of banks' health, and their willingness to invest in the industry. In upcoming days, it will become clearer how investors will dissect the nitty-gritty of the stress-test results.

Already, some critics are saying the exercise is flawed, even though Geithner, in a New York Times op-ed Thursday — before the results were released — stressed that regulators used "exacting" loss estimates and "conservative" earnings estimates.

The better-than-expected stress-test results also won't directly boost lending, says Jim Wheeler, a partner at Bryan Cave law firm, which represents banks. "What bankers want is borrowers who can pay loans, and this doesn't change that."

Q: How, and when, will banks pay back government bailout money?

A: Banks that don't need to raise additional capital will be able to repay government money. But to do so, they will need to show that they're able to issue debt without FDIC guarantees, as some banks have already begun to do.

It's unclear whether it'll be weeks or months before banks start paying the government back. But Bank of America CEO Ken Lewis said Thursday, "Our game plan is designed to help get the government out of our bank as quickly as possible."

Q: How will banks boost their capital?

A: Most banks will sell assets or issue common stock. Bank of America and Wells Fargo, which need to raise $33.9 billion and $13.7 billion in capital, respectively, said that strong upcoming earnings should also mitigate the capital shortfall. Both announced plans to sell common stock.

While the large national banks will have challenges of their own raising the needed cash, regional banks might have even more difficulty, says Christopher Whalen of Institutional Risk Analytics. "They don't have as big a market" to tap for investment capital, he says.

Q: Is my money safe with banks?

A: In releasing the results of the stress tests, Fed Chairman Ben Bernanke said that they were "not tests of solvency." In other words, the tests are not indicators of banks' ability to keep their promises to consumers. "There's no direct cause between the stress tests and anything (affecting) bank customers," says Greg McBride, analyst at Bankrate.com.

Even if your bank fails, your money is often insured by the FDIC. Until the end of 2009, the government will cover up to $250,000 in transaction accounts, such as checking or business payroll accounts. After that, up to $100,000 per depositor, per bank, is generally covered.

Q: What determined if banks needed a bigger capital cushion?

A: Regulators have been focusing more on something known in the accounting world as "tangible common equity," or TCE, in trying to gauge banks' ability to weather even stormier economic times.

That's because common shares are a conservative way to measure how much capital a bank has to cover losses. In light of the crisis that the banking industry has been through, regulators now are paying particular attention to TCE because it basically measures how much common shareholders would get if the institution were liquidated.

In the past, regulators and investors measured a bank's financial health mainly by its so-called Tier 1 capital level. Tier 1 capital includes common equity, but also preferred equity and retained earnings.

Under the bank bailout, the government gave banks the opportunity to boost their capital, by taking preferred equity in the banks that could later be converted — if needed — to common shares.

While most banks are well capitalized by Tier 1 standards, they're struggling to raise adequate capital to cover future losses. This paradox caused investors — and regulators — to increasingly focus on common equity as a measure of banks' financial health.

Contributing: Paul Davidson, Pallavi Gogoi, Matt Krantz and Adam Shell