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Stress tests fail to lift cloud of uncertainty

By Yang Zhen (China Daily)
Updated: 2009-05-09 07:44

A customer leaves a Bank of America ATM booth in Charlotte, North Carolina. [Agencies]

The US government's "stress test" results, though better than what most analysts had expected, are insufficient to prove the soundness of the financial system, leading Chinese economists said on Friday.

The US Federal Reserve said on Thursday that 10 of the 19 large banks would need to raise $74.6 billion in new capital to withstand losses if the economic recession worsened.

The results show that losses at the banks under the worst-case assumptions could total $599.2 billion, or 9.1 percent of the total loans, over two years. Mortgage losses account for the biggest risk, at $185.5 billion. Trading accounts were the second-largest vulnerability, with potential losses of $99.3 billion.

US officials hoped the tests would restore investor confidence that not all banks are weak, and that even those that are can be strengthened.

"The methods that the Federal Reserve applied in its stress test failed to address the 'systematic risks' the banks may face," said Zhao Xijun, deputy director of the Institute of Finance and Securities at the Renmin University of China in Beijing.

According to Zhao, US banking regulators evaluated the risks of the banks' products under different categories separately and did not pay any attention to the correlation between these products during the economic downturn.

"Different financial products may generate more losses when the whole economy is in a slump," Zhao said.

The worst-case assumptions were based on an unemployment rate of 10.3 percent next year, an economic contraction of 3.3 percent this year and a 22 percent decline in housing prices. That rate of loss would be higher than any other since 1921.

However, some critics in the US expect the economic estimates used by regulators, including the unemployment rate touching 10.3 percent by 2010, were perhaps not severe enough.

Economists in the US are betting that the Labor Department would report on Friday morning that the nation's unemployment rate, which has been spiraling higher in recent months, hit 8.9 percent during April.

Despite being asked to raise billions of dollars in new capital, the US banks' capital adequacy ratio still looks decent on their balance sheets, when compared with that of their Chinese peers.

Bank of America, for example, maintained a 14.03 percent capital adequacy ratio at the end of the first quarter in 2009, according to its latest earnings report. That compared with the 12.11 percent capital adequacy ratio in the first quarter at Industrial and Commercial Bank of China, the country's biggest commercial lender.

Zhao pointed out that the asset structure in the US banks contributed to their seemingly solid capital adequacy.

"Over 50 percent of the US bank assets are in forms other than loans, while outstanding loans account for over 90 percent of Chinese bank assets. It's much easier to assess the risks of loans than other kinds of financial products," Zhao said.