How Safe Are Our Banks?

Are We In Danger of Another Bank Crisis?

How Safe Are Our Banks?
February 25, 2016

The collapse of Lehman Brothers in 2008 highlighted how close we came to a global financial collapse during the Great Recession. In response to the near-collapse, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, in order to prevent further bank failures and/or bailouts that eventually fall onto the backs of taxpayers. Dodd-Frank set new requirements and restrictions on banks to keep them sound and able to withstand a future financial shock.

After five years of Dodd-Frank, are banks any safer? This point is arguable, but one recent development gives cause for concern. Standard & Poor's (S&P) downgraded eight of the largest U.S. banks with respect to their non-operating holding company ratings. Those eight banks are as follows: Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), Morgan Stanley (NYSE: MS), Citigroup (NYSE: C), Wells Fargo (NYSE: WFC), Goldman Sachs (NYSE: GS), Bank of New York Mellon Corp (NYSE: BK), and State Street Corp (NYSE: STT). The operating units are not affected by the downgrades, just the holding companies.

S&P's decision was not based directly on the banks themselves but the uncertainty about whether the U.S. government would come to the rescue if banks were threatened by another market meltdown. Given the focus of Dodd-Frank, that is a reasonable concern. Banks must now undergo regular "stress tests" (formally known as the Comprehensive Capital Analysis and Review) to measure their ability to handle certain worst-case market scenarios, with the intent of making sure that the U.S. government does not have to come to their rescue anymore.

During the last stress test in March of 2015, the major U.S. banks all passed. Why are there concerns if that is the case? Because several of the largest banks required revised proposals to meet the criteria, and one was passed conditionally upon submitting an improved plan in September (which it did). All four of those banks are in the above list of the eight.

The Federal Reserve is keeping the pressure on the big banks to retain more capital in reserve, which goes against their interest — cash that a bank has to hold in reserve is not out in the marketplace, earning the bank more money. Lower returns ensue, as do lower profits.

In October 2015, the Fed released a proposed rule for six of the eight banks to hold an extra $120 billion to meet regulatory thresholds that prevent future bailouts or intense market disruptions. At least the Fed has given banks another year to come up with supplementary leverage ratios — a measure of the amount that banks can borrow relative to assets on hand. Effectively, these are caps on the ratio of money loaned out to money held within.

The global view of the banks is not any better. The international Financial Stability Board (FSB) that was formed in the wake of the Lehman Brothers collapse concluded in November that the 30 largest banks in the world might have to raise up to $1.2 trillion by 2022 to prevent future bailouts. That may not be as grim as it sounds, because the goal could potentially be met by managing the risk of the debt. As old riskier debt matures, replace it with less risky "FSB-compliant" debt. Easier said than done, but still possible.

In essence, the banks are less likely to fail because multiple organizations and agencies are keeping them in check. The real worry will be if foes of bank regulation manage to roll back the current checks on the system. Banks will not adequately regulate themselves.

To see what Americans think about bank safety, check out the results of our exclusive survey in an infographic.


Photo ©iStock.com/Hendrik5000

  Conversation   |   9 Comments

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Steffanie | 02.25.16 @ 18:01
Glad to hear the Federal Reserve is keeping an eye on the banks. It does make me feel a little more secure.
Erin | 02.25.16 @ 18:02
It always amazes me that people seem to think these businesses (not just banks) will regulate themselves out of the goodness of their hearts. They are in it to make money, and who cares about who gets stepped on and crushed along the way?
Elaine | 02.25.16 @ 18:02
I have been hear a lot of whispers about bank issues again and how it is coming a time when they will only let you have a hand full of money per day. I hope that is just talk but with articles like this, it makes me wonder if there is truth to it.
Carla Truett | 02.25.16 @ 18:02
I'm glad the Federal Reserve is keeping the pressure on these big banks but I'm still a bit gunshy.
Sarah | 02.25.16 @ 18:03
well it's good to know that at the present, banks are still safe.
Stokes | 02.25.16 @ 18:09
I prefer online banks and credit unions. I've been screwed repeatedly by big banks.
Kaila | 02.25.16 @ 18:10
I would not be surprised at all if the whole banking system crashed, it has so many flaws. It is good they are safe for now according to this article but I still am hesitant about many of them.
Irene | 02.25.16 @ 18:10
I suppose this makes me feel a little bit better, though I don't have 100% trust in banks
Vaughn | 02.25.16 @ 18:13
I have kind of heard about the bank having issues recently but didn't think that it was serious so I pretty much just ignored it. After reading this article though I feel like I need to start listening more closely. It is nice to know that they are trying to prepare the banks for a worst case scenario so that they don't have to be bailed out again.
$commenter.renderDisplayableName() | 12.08.16 @ 04:30
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