An update on America’s riskiest banks | FT Alphaville

An update on America’s riskiest banks

Cast your minds back to the SCAP — that’s the Supervisory Capital Assessment Program, better known as the US banking stress tests of spring 2009.

The results showed Bank of America, Wells Fargo and GMAC as requiring the most amount of capital; in other words, they were expected to generate the most losses.

So, it’s with interest to read the below from a just-published Federal Reserve discussion paper, aimed at creating a sort of ‘systemic risk indicator’ for banks.

The idea behind a systemic risk indicator — and this one looks like it’s based on CDS spreads and asset correlation — is that you can then measure systemic importance against it.

Enough of the technical details though, here are some of the interesting bits:

More important, we can rank the systemic importance of [large complex financial institutions] in the U.S. banking sector. By our relative measure since the summer of 2007, Bank of America and Wells Fargo’s contributions to systemic risk have risen, JPMorgan Chase has seen some decreases, and Citigroup’s share has remained the largest. The relative contributions to systemic risk from both consumer banks and regional banks seem to be increasing somewhat since 2009, possibly because of the worsening situations in the commercial real estate and consumer credit sectors, which typically lag the business cycles. Overall, our analysis suggests that size is the dominant factor in determining the relative importance of each bank’s systemic risk contribution, but size does not change significantly over time, at least within a reporting quarter. The obvious time variations in the marginal contributions are driven mostly by the risk-neutral default probability and equity return correlation. In essence, the systemic importance of each institution is jointly determined by the size, default probability, and asset correlation of all institutions in the portfolio.

Finally, our measure of the systemic importance of financial institutions noticeably resembles the SCAP result. Based on the data through December 31, 2008, the 19 banks’ contributions to the systemic risk indicator are mostly in line with the SCAP estimate of losses under an adverse economic scenario as released on May 9, 2009, with an R-square of 0.62. Goldman Sachs, Citigroup, and JPMorgan Chase, in particular, would be viewed as contributing more to systemic risk by our method (from a risk premium perspective) than by the SCAP results, while Bank of America and Wells Fargo would be viewed as more risky by the SCAP results (from an expected loss perspective) than by our method. Note that our systemic risk measure also contains a risk premium, while the SCAP estimate is based on statistical expected loss.

Related links:
Sneaky Citi, tricksy bailout – FT Alphaville
Geithner doubts ability to spot vital banks
– FT