The Treasury, the Federal Reserve and three other regulators - the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision - said today that they would impose severe stress tests on US banks, which could be compelled to raise additional capital as a result.
The banks would be asked to simulate "a more challenging economic environment" than the current crisis, and, depending on the results of the test, could then be told to increase their capital reserves - if possible by issuing more equity to private investors, but if necessary through capital injections from the US government, which would receive convertible preferred shares in return.
The additional capital is not needed at the moment. "Currently, the major US banking institutions have capital in excess of the amounts required to be considered well capitalised," the Treasury said. But it could be needed to keep banks functioning "under an economic environment that is more challenging than is currently anticipated".
The Treasury emphasised that, despite its willingness to take further stakes in banks, it had no intention of nationalising them. "Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Programme is that banks should remain in private hands," it said. This follows suggestions from several prominent officials, including former Fed chairman Alan Greenspan and Senate Banking Committee chairman Chris Dodd, that bank nationalisation might be the only way out of the crisis.
Instead, the Treasury says, today's announcement simply means at most a temporary increase in capital requirements. But across the Atlantic, a consensus is growing that raising capital requirements -at least during the current crisis - would cause severe damage.
Speaking this morning, European Central Bank president Jean-Claude Trichet told a London conference that, while increased capital reserves would be a good idea in the medium term, "in the present circumstances, banks should not be requested to hold more capital than is required by the existing capital framework".
Increasing capital requirements in the depths of a downturn would be procyclical - forcing banks to sell assets in already illiquid or distressed markets would make the downturn worse by forcing asset values still lower.
Last month, Adair Turner, chairman of the UK Financial Services Authority, also called for higher capital requirements in the medium term, but said that during the current crisis, banks should be prepared to draw down capital to the minimum possible level.
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