Researchers from the San Francisco Federal Reserve Bank all agreed recently, banks need large capital buffers in order to protect themselves from unexpected loan losses, such as those felt from the current downturn. Lenders typically sock away money in order to cover any future losses, based upon past mortgage and other loan performances.
As of right now, these “safety net” reserves, put aside by lenders, have not been enough to cover the hostile drop in home values which sent, more than projected, numbers of homeowners into foreclosure and even delinquency. This was all expressed in the most recent San Francisco Federal Economic Letter.
Group Vice President in Financial Research from the San Fran Feds, Fred Furlong, wrote, “Even a more forward-looking provisioning process would not have fully addressed bank vulnerability to the extraordinary events of the past few years.” Zena Knight, a San Fran Federal Research Associate added, “guarding against such shocks is the role of capital. The lesson of the financial crisis is that the buffer against downside risk must come in the form of higher bank capitalization.”
Many Federal officials would like “stress tests” conducting more frequently, to ensure banks in the US are generating and managing enough capital to face any shocks down the road. In general, it seems banks must improve and increase their capital to protect themselves against unforeseen loan losses. In 2009, the Feds’ “stress tests” were given to 19 of the US’s biggest bank holding companies.
The argument that banks need to boost capital to guard against future unexpected bursts of loan losses is in keeping with the Federal Reserve’s so-called stress tests conducted last year on the 19 largest U.S. bank holding companies. The results prompted the Feds, then, to urge banks to gain more capital.