The New York Times editorial board isn't so sure big banks actually passed the Fed's stress test

Janet yellenGetty Images / Chip SomodevillaFederal Reserve Bank Chair Janet Yellen holds a news conference following a meeting of the Federal Open Market Committee at the Fed headquarters March 18, 2015 in Washington DC.

The New York Times isn’t so sure about the results from the Federal Reserve’s latest round of stress tests.

In an editorial published over the weekend, the New York Times cites data from Thomas Hoenig, vice chairman of the FDIC, who, in contrast to the Federal Reserve, found that capital ratios at the 8 largest banks in the US averaged 4.97% at the end of 2014, far lower than the 12.9% found by the Fed’s own stress test.

“Capital ratio” refers to the amount of cash relative to assets banks have on their balance sheets, reflecting how much of a loss a bank can endure before potentially needing a bailout, as many banks did during the financial crisis.

The Fed conducts stress tests on banks annually, running banks through a series of potentially adverse scenarios to find how they would hold up under certain types of financial distress. The stress tests are part of Dodd-Frank.

At issue in Hoenig and the Fed’s calculations are how derivatives are accounted for.

Here’s the Times:

The discrepancy is due mainly to differing views of the risk posed by the banks’ vast holdings of derivative contracts used for hedging and speculation. The Fed, in keeping with American accounting rules and central bank accords, assumes that gains and losses on derivatives generally net out. As a result, most derivatives do not show up as assets on banks’ balance sheets, an omission that bolsters the ratio of capital to assets.

Mr. Hoenig uses stricter international accounting rules to value the derivatives. Those rules do not assume that gains and losses reliably net out. As a result, large derivative holdings are shown as assets on the balance sheet, an addition that reduces the ratio of capital to assets to the low levels reported in Mr. Hoenig’s analysis.

The Times concludes that given these differences, the Fed ought to re-think its approval of the banks’ capital positions.

Read the full editorial at here ยป

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