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.....Banks Stress Over Fed Test Methods
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.....Banks Stress Over Fed Test Methods

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.....Banks Stress Over Fed Test Methods

Executives at some of the 19 large banks whose "stress test" results were released this month have a message for the Federal Reserve: Show me the math.

The Fed held five conference calls over two days with the banks last week that were dominated by questions about how the Fed arrived at the capital levels it projected banks would maintain in a steep downturn, said people familiar with the situation.

Healthy institutions want to understand why there were some large gaps between their own capital estimates and the Fed's, according to people close to those banks. Some of the five lenders that didn't pass the test say questions about the Fed's scoring complicate reapplying for approval to raise dividends or buy back stock, said people close to those companies.

"Every bank I know had numbers that were better than the Fed's numbers," said one person close to several banks.

The Fed hasn't kept everything secret. Last November it published test assumptions, such as a 13% unemployment rate in a U.S. recession.

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But the Fed is resisting full disclosure of its methodology, hoping to retain the flexibility to make future changes and prevent the banks from gaming the numbers, according to people familiar with the process. The central bank is writing rules that will frame how annual stress tests are conducted in coming years, a step mandated by the Dodd-Frank financial-overhaul law.

The questions come even though the results released March 13 are widely perceived to have built confidence in the U.S. banking system—in contrast to a series of tests in Europe that were derided by some investors as too easy. Many banking firms won Fed approval to pay tens of billions of dollars in increased dividends and share buybacks, and bank stocks rose following release of the results.

Fed Chairman Ben Bernanke told lawmakers last Wednesday that the results showed big U.S. banks "essentially were able to meet a reasonable level of capital even following the losses associated with" a major economic downturn that might accompany a severe crisis in Europe.

Even so, the rollout of results was marred by possible leaks, miscommunications about when the information could be disclosed and mistakes in some of the Fed's loss projections for particular banks.

Questions about how the Fed arrived at its numbers arose soon after the results were released. Among the most prominent critics were three banks deemed by the Fed to fall short of various capital-adequacy targets under its so-called stress scenario, which included sharp declines in housing and stock prices.

Auto lender Ally Financial Inc. said the Fed's "assumptions" were "inconsistent with the company's view." MetLife Inc. MET -0.29% said the "bank-centric methodologies" used by the Fed weren't appropriate for insurance companies. The largest lender to fall short, Citigroup Inc., C -0.55% said it would "engage further with the Federal Reserve" and that disclosure of Fed methods "will encourage a level playing field globally."

But the results of healthy banks also raised questions among some bankers. J.P. Morgan Chase JPM +0.23% & Co., which received approval to raise its dividend and buy back stock, was among banks that had projections that were quite different from the government's numbers. J.P. Morgan told investors in February that its Tier 1 common capital ratio in a severe downturn would be 8% through 2013. The Fed's estimate of that same buffer was 5.4%. A J.P. Morgan spokesman declined to comment.

Comments on a draft of the Fed's rules for annual tests are due at the end of April, and letters from big banks are likely to reflect their frustrations as they seek to influence how those tests are conducted and what information the Fed publishes.

The more banks know about how the Fed plans to use the data they provide, the more those same banks can try to manipulate the information beforehand in hopes of achieving better results, said Douglas Elliott, a former investment banker who is now a fellow at the Brookings Institution think tank. "The banks have a lot more smart people who can focus on gaming the rules" than the Fed does to counteract those efforts, he said.

By not sharing its models with banks, the Fed is able to see how well the banks perform in coming up with their own models and stress testing, added Eugene Ludwig, a former comptroller of the currency and now chief executive of financial-consulting firm Promontory Financial Group. "That's part of [banks'] own risk-management abilities," he said of the Fed's thinking. "We don't want to give them the answers to the quiz before we hand it out."

One bank chief financial officer said he would have preferred to have had an interim discussion with the Fed so he could have addressed any differences in the analysis before it was made public. The Fed did so in 2009, during a first round of tests, and was criticized by some for sharing too much information with the banks.

In the end, bankers know they can't press too hard if they hope to get the green light for new capital actions.

"The government can do whatever they want," said a top officer at one of the banks recently tested by the Fed.

Banks Stress Over Fed Test Methods - Yahoo! Finance

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