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Markets Update: Banks’ Stress Tests


Richard Ramsden of Goldman Sachs Research explains what the results from U.S. banks’ latest stress tests say about the health of the industry.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
Welcome to our exchanges, Goldman Sachs market Update for Thursday July second, each week we check the Middle Lyric Ross the firm to get quick, take on what they're watching in markets on Jake Stewart global head of court. medications your comment and my guess today's is Richard Ramsden, who runs the financial group in global investment research and has primary oversight of the universal Enlarge CAP bank sector for Goldman Sachs, Richard covers one of the big banks, but we should note that, of course, he doesn't cover Goldman Sachs itself, Richard Gregg Heavy, on the problem trade. Thank you very much so last week Richard the Federal Reserve announced the results of its latest stress tests of american banks. You approached this time was a little different than previous stress test. What FED do that was different and why so this a task to its being in place now for about a decade and
they did, is they made a change this year, which is really being a long time coming, whereby the fat, I think, has tried to remove themselves a little bit from the minutiae of bank setting dividends and buyback so under the prior test. The way, what is the banks would be given a scenario by the Federal Reserve? That typically word reflect a period of various their economic contraction. The banks would take nor are they would run it. They would figure out what they thought. The losses would be under that scenario and based on they would come up with a capital return ask so they would say what they wanted to ask for in terms of both dividends and by backs over the next twelve months and the FED would look
the results of that analysis. It would run their own test and in essence, they would give the bank either a passport fail. So the bank would either get permission to return that capital or they wouldn't study this year. The way the test works is the bank's still given a scenario. They run the scenario, but instead of asking for a predetermined amount of buyback, some dividends. What that given is a Kapital ratio that they need to maintain over the course of the next twelve months and provided the bank is above that capital, Russia, in very they ve, got a lot more degrees of freedom in terms of their ability to either buyback stock or increase dividends or growth balance sheet. So, as I said I it really a purpose. It was ten years after the global financial crisis, the FED wanted to step back from being involved in day to day decisions around by banks and evidence, but they didn't want to allow banks to increase systemic risk and become over lever in the event of a downturn, so
stress tests. This year was designed really before Kobe, hit hard headed the FED handled the fact that their hypothetical scenario was somewhat preempted by a real life stress test. So this trust with sat in January of this year. So the scenario was given to the banks in January. At that point, covered was firstly a risk, but obviously, at that point I don't anybody could have really had any idea as to just now how damaging from an economic perspective covered. I was gonna, become both within the Eu S, but also globally. So I think it's definitely fair to say that this task did not reflect the economic until it was seen as result of covert what I think, Important, though, to keep in mind, though, is the banks have been running economic scenarios now for the best part of a decade every one of these, nor is, is different because the banks have been asked distress for lorries.
straits for higher interest rates for a collapse of activity in the emerging markets for a collapse in commodity prices. I think it's impossible to really ever perfectly envisage he's going to proceed and economic downturn. The key thing around trusting those to make sure that banks are actively thinking about the capital but the running were about the risks that they have on the balance sheet and around what then plan B is if you do have the severe economic downturn it also even though the bank's didn't prepare for this exact economic downturn there, have prepared for something similar in the past and even on the snorri, though, given in January, which is this very sharp economic contraction? The results a rapid pick up in unemployment. A significant picked when volatility in financial markets, and as a result of that, pick up and credit losses, so the region to the tests are now in the big picture
think it means for the ability of the banks. You look at to manage their capital going forward. Did they get as much freedom as they would have liked? You are so much. I think If you look at the results of the tests, it was actually pretty encouraging. I mean so here you put these banks, this period of severe economic stress and even the building about stress and even after building in dividends for the next year. The banks, a hundred and forty billion dollars of access capital. To put that in prospect, four hundred and forty billion dollars of access capital would support well in excess of a tree in dollars spots longer us ass, which is greater than ten percent of total loans outstanding. So even in parry. The stress what this tat showed is pretty much. Every single bank had access capital. Another is significant capital to support loan growth and demand, from financial institutions for access to liquidity, and I think that was very encouraging. So looking back at them,
gets reaction to this. How do investors think about the results of this round, and how do they view bank socks going forward? So I think the market likes them also the test, I think what caused the sun, often banks talks, was ready, two things. The first is that the banks are going to have to resubmit the stress tests this year and we want given the exact scenario. But clearly it's going to be worse than the one that was given in January. Mr Rehn I think what the market wanted was closure around. What is the capital requirements, the banking industry of the next twelve months? We didn't get that, in fact, what we got is what the capital required he's going to be for the banking industry over the next three to six months, but then there's gonna be another task which is going to result in a different capital requirement and the market. Obviously dislike uncertainty. The second thing is the FED did impose some additional restrictions on banks.
Reality to pay dividends. So if a dividend in any one quarter exceeds the average of the last four quarters worth of net income, he was a bank will not be able to pay at UNESCO. there is an additional tasks, has been added around dividends, but we would probably result in more banks, either reducing or cancelling their dividend over the next six months than about the market at initially envisaged. So you and I talked about global financial crisis and the impact it had a banks. Last on banks were very much at the centre of the crisis in required direct government support in the U S and and elsewhere. So far, there has not been the case in this downturn. The feds done something for markets which have helped banks, but not directly why the banks hold up better in the middle of this crisis. You know, I think they held up better because of the global financial crisis, and also, obviously, if you go back to two thousand and eight, the banks were already seen in some ways as the reason that you had the severe economic downturn and look
The reason that there was that view is because the bank's went in super two thousand lakes global financial crisis in an overloaded position either didn't have enough capital, they had very high concentrations of risk, especially in mortgages and real estate and when the crisis had, the banks were ready horse to deliver at the sight time that the economy was shrinking. Nor so really, I think, was a view at the time, which was that the banks, are actually amplifying is economically turn because they're not in a position to continue lending and to continue providing acquitted the financial markets and, coming out of it, thousand tonight. I think everybody agreed the robot needed to change, and in two thousand and ten you had Dodd Frank about it: produced a whole set of additional regulations that banks had to ahead to both in terms of capital, but also in terms of how they think about the courtesy I would say. The most important change coming out of two thousand and eight was the stress test. Banks have really being forced to
every year? Ok, what happens if there is the severe economic shock? business. What happens to my capital? What happens to my liquidity and how do I prepare for it, and I think the real the banks and held up better this time round and in two thousand and eight is the banks are really the only industry that are really had to say about a scenario similar. we currently going through, which is You get an external shock that was in a very significant contraction in economic activity in a very short period of time, the rest to make significant pick up in low losses and volatility and make sure that they can withstand shock in effect, what we had over the causes this year is a real life's trust us effectively. What we have gone through is unemployment. going to ten to fifteen, potentially
Ten to twenty percent. You ass. He had a very significant pick up in terms of financial market volatility, and the banks have proven that they can withstand that type of shock and still provide credit to the real economy. I think one of the most important I think statistics is that in the first three months of this year, bank balance sheet at least the largest banks expanded by ten percent NASA banks really could. for eight as a stabilizing influence over the course of this economic downturn by providing credit companies that will obviously in desperate need of access to liquids. He lay think that's been really important because, as I said earlier, banks in two thousand and eight amplified by economic shock this You could argue that have operated much more as a stabilizing flights, or maybe the banks can export their stress tests, expertise to other industries going for that being a businesslike. Later, this What will begin in earnings reports from the major yes banks in foreign banks? What would expecting to see across the larger banks in this environment? It still pretty volatile? Yes,
like and what we want to see as a continuation of what we saw in the first quarter, which is at last provisions, will continue to be very high. You're, so the banks- sat alone was provisions at the end of March. At that point, I think that the EU was unemployment was likely to peek at ten percent banks. Now I think how we view that unemployment is gonna peek at a higher number you're, so reserves for low losses, a settled, a forward looking basis, so they will be increasing their reserves, reflecting the fact that unemployment is slightly higher than what they had envisaged, but against that this high level of volatility in financial markets has translated to a high degree of activity in capital markets and, as a result, I do think that pre provision operating profits to be a mountebank earns before they have to book a prick. he's gonna, continue to be actually quite good enough, so Earnings of Rome will obviously be weak. I arrived acting reserves that they need to go. But I dont think that money Thanks, you gonna, lose money. bottom line and I think tank selection
continued to see capital ratios stay around the level that they were in the first quarter. I write will have more to discuss after earnings Richard thanks for joining us today. Thanks law, that's for this week's markets. Update on exchanges of Goldman Sachs indication is that check out or other episode this week, with Christian Olsson on what's driving growth in alternative capital markets, thanks for this I hope everyone has a great long weekend is podcast- was where did on Wednesday, to lie first near two thousand trying thanks for this, all price references and market forecasts correspond to the date of this recording. This podcast should not be copied, distributed, published or reproduced in whole or in part. The information contained in this package does not constitute research or recommended from any Goldman Sachs Entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast and any law
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Transcript generated on 2021-07-02.