Stress tests on American banks

The Fed has released details of stress tests conducted on American banks and its own conclusions. In its view, there is need for additional common equity to the extent of $75 billion as against the requirement of $185 bn as on 31st December 2008. Apparently, the situation is improving.

What is causing concern is that there continues to be understatement of risk and capital requirement. Fed is targetting only 4% of risk-weighted assets as common equity requirement which is 50% of total capital requirement. Actual assets are 160% of risk-weighted assets. (Common equity requirement is stated as 2.5% of actual assets and hence this derivation.) In other words, a typical asset carries a risk-weight of 62.5% only. Fed continues to have total trust in risk-management capacity of the banks! Some institutions never seem to learn!

European banks have nearly 7% of risk-weighted assets in the form of common equity, that is way above the American banks.