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Document Type

Case Study

Abstract

Due to continued stress during the Global Financial Crisis, the US Treasury released a series of additional measures in February 2009 that included a mandatory stress test for major U.S. bank holding companies (BHCs), backed by government capital. The stress test, known as the Supervisory Capital Assessment Program (SCAP), tested the capital adequacy of the 19 U.S. BHCs that had more than $100 billion in assets. A large interagency team of regulators and other experts estimated losses and income under two hypothetical scenarios for the group of BHCs: a baseline that reflected the consensus belief about the course of the current recession, and a more adverse scenario that reflected a deeper recession. The estimated loan losses under the more adverse scenario were higher than realized losses at any point in U.S. history. Ten of the 19 BHCs were required to increase their capital by a total of $75 billion, of which $65 billion had to be in the form of common equity. The 10 BHCs had six months to increase capital by issuing new shares, selling assets, curtailing payments to shareholders, or changing the composition of their capital by converting preferred shares or debt into common equity. If those sources were unavailable, they could apply for government capital through a backstop facility known as the Capital Assistance Program (CAP). Other banks, even if they were not part of the SCAP exercise, could also apply to CAP. Under CAP, Treasury would buy mandatorily convertible preferred shares in an institution, subject to certain restrictions. The shares had onerous terms to encourage institutions to find other sources of capital: they paid dividends of 9 percent, required a halt to dividend payments on other shares, came with limits on executive compensation, and contained warrants that allowed Treasury to purchase additional common stock. Ultimately, no institutions applied for CAP funds, and it terminated in November 2009. Academics and policymakers praised the stringency of the test as well as the Federal Reserve’s controversial decision to publicly release the details and results. They also argued that the availability of government capital through CAP was an essential fallback option supporting the stress test exercise. The Fed intended its capital targets to be high enough that banks could continue lending to creditworthy borrowers during an economic downturn, rather than merely survive. Ultimately, all but one of the institutions that the stress test identified as needing capital were able to obtain private capital without further government support.

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