Stress tests show $75bn buffer needed

US regulators on Thursday directed the nation's largest banks to add $74.6bn in additional equity following a three-month stress test designed to measure their ability to withstand an economic downturn.

The results come after a week of leaks which braced markets for the news that billions of additional dollars would be needed to bolster US banks. The stress tests revealed that 10 of the 19 banks involved in the analysis carried out by government will need more common equity.

Bank of America, Wells Fargo, GMAC and Citigroup will need to raise $33.9bn, $13.7bn, $11.5bn and $5.5bn, respectively. However,JPMorgan Chase, Goldman Sachs, American Express and State Street  will need to raise no additional capital.

Ben Bernanke, chairman of the Federal Reserve, said on Thursday that he was pleased with the results of the stress tests and that he thought they would restore confidence in the condition of the US banks.

Financial stocks were down on Thursday as investors reacted to a disappointing US government bond auction. Bank of America shares finished up 6.46 per cent to $13.51, while Citigroup fell by 1.30 per cent to $3.81 and JPMorgan Chase dropped 5.32 per cent to $35.24.

Wells Fargo, which was off by 7.75 per cent to $24.76 a share, announced a $6bn common stock offering after the market closed but before the release of the stress test results. Meanwhile, Morgan Stanley, whose shares fell by 4.81 per cent to $27.41, said it would offer $2bn of common stock and $3bn of debt that is not backed by the Federal Deposit Insurance Corporation.

Regulators have said that the tests aim to ensure that even in an adverse economic scenario banks would still have tier one capital of at least 6 per cent of risk-weighted assets and tangible common equity of at least 4 per cent at the end of 2010.

Banks will also be asked to outline how they will, over time, repay existing government capital injections (in the form of preferred shares) and reduce reliance on debt issued under a government-guaranteed programme.

The stress test results were originally to be released on Monday, but regulators delayed the release after some of the lenders objected to government demands that they needed to raise more capital. Authorities have tried to stage the disclosure of the tests carefully so as not to disrupt the markets with the results.

Critics of the stress tests have argued that the process is flawed and that banks that are said to require additional capital will be labelled as "failed" by the market and will find it difficult to raise new capital without government help. Others, such as Warren Buffett, have said that the tests apply a one-size-fits-all approach to banks with different portfolios and fails to account for their strengths.

Each bank that has been told to raise additional equity will have until June 8 to present a plan to regulators explaining how it intends to do so and until November 9 to put the plan in place.

Copyright: The Financial Times Limited 2009