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Goldman Sachs faces long odds in getting the Federal Reserve to reconsider its disappointing grade in this year’s bank stress tests, according to regulatory experts.
At stake is roughly $6bn, which is how much extra capital the Fed is likely to require the bank to hold in order to cover potential losses following this year’s stress test. The higher capital requirement could curtail Goldman’s capacity to lend and trade, as well as crimp profits and limit its ability to reward investors with share repurchases and dividend payments.
If Goldman is successful in getting the Fed to lower that amount, it would be the first bank to do so in four years, which is when the central bank rolled out the most recent version of its stress test and instituted a new appeals process. Since then, banks have appealed their stress test results eight times, all of which have been rejected by the Fed.
“The chances of success are close to zero,” said Francisco Covas, who is the head of research at the Bank Policy Institute and has previously called the appeals process “inadequate” and “largely ineffective”.
Goldman, like other large US banks, passed the Fed’s annual financial fitness test. But the test predicted Goldman would lose more than $40bn in a severe economic downturn, or nearly half the capital that regulators required it to have to cover losses last year, a worse result than any of its large rivals.
Last week, Goldman’s chief executive David Solomon took the rare step of criticising this year’s stress test. He said the Fed’s scoring didn’t reflect the evolution of the company, which has been exiting certain businesses and shrinking outside investments.
“We will engage with our regulator to better understand their determinations,” Solomon said in a statement at the time.
Goldman declined to say whether it would formally appeal its stress test outcome. Banks have two weeks to appeal their stress test results. It was not clear on what grounds Goldman could appeal its result.
Goldman in some ways fared better on the Fed’s stress test than it did on its own, which the banks also had to disclose last week. Its internally run stress test predicted a bigger drop in revenue and larger trading losses in an economic downturn that the one run by the central bank.
The Fed, though, estimated Goldman’s expenses would be higher than it did, leading to the central bank’s overall higher stress test loss estimate. Goldman and others have long argued the Fed fails to take into account that an economic recession would lead to lower bonus payouts and other potential cost savings.
In a statement to the Financial Times, the firm said: “It’s not at all clear what factors would explain the diverging results year over year.”
The Fed’s stress test was mandated by Congress as part of the Dodd-Frank post-financial crisis reforms. Regulatory experts say there is some evidence that the Fed adjusts the stress test from year to year based on the feedback they get from banks. In this year’s test results, the central bank said it had started to factor bonus cuts into its analysis.
But banks and their lobbyists have complained that the review process is stacked against them.
“There is little, if any, evidence that the reconsideration process for appealing stress test results or stress capital buffers provides any meaningful check on the Fed’s discretion,” Jonathan Gould, a top banking industry lawyer at Jones Day said in written testimony to the House Financial Services Committee last week.
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