Will CD Rates Move Higher at Banks that Didn’t Perform Well in the Federal Reserve Stress Test?

Banks that didn't perform well in the Federal Reserve stress test might feel the need to offer higher CD rates to increase their capital reserves. The largest bank holding companies in the United States have to go through an annual stress test to show that they can withstand extreme hypothetical economic scenarios.

Will CD Rates Move Higher at Banks that Didn't Perform Well in the Federal Reserve Stress Test?The stress tests that the Federal Reserve conducts were borne out of the financial crisis when many large banks were in deep trouble and needed more capital to survive. Overall, all the largest banks in the United States fared pretty well in this round of tests, which include a hypothetical economic model of sharp economic contraction, a large jump in the unemployment rate, and a large drop in stock prices.

The "stress scenario" model that the Fed applies in their test is a very unnerving situation if it were to actually happen. The test includes includes a top unemployment rate of 12.1 percent, a drop of more than 50 percent in stock prices, and a drop in housing prices of more than 20 percent. The test also includes the 18 bank holding companies that are tested to lose a combined $462 billion during just over two years in this hypothetical scenario.

The good news is that (on paper) none of the 18 banks would fail since all of the banks have increased both the quality and quantity of bank capital since the "Great Recession." The test also concludes that banks can continue to lend to consumers and businesses, even in times of economic difficulty, though if that scenario were to happen would banks actually be willing to lend? If history is any indication, probably not.

When the financial crisis hit, banks turned off the lending spigot to individuals and companies. Two of the big three automakers had to be bailed out by the federal government since no investors or lenders would step up to provide capital to General Motors and Chrysler during the financial crisis.

The test results list the bank capital ratio for Q3 2012 and what the capital ratio would be for the banks in the test scenario in Q4, 2014. All banks have enough capital to withstand the test but more than half of the banks just meet the minimal capital requirements. The banks with the minimum capital requirements include Ally Bank, U.S. Bancorp, SunTrust, Wells Fargo, Regions Financial Corporation, The PNC Financial Services Group Inc, KeyCorp, Fifth Third Bancorp, Capital One Financial Corporation, BB&T Corporation.

If you invest in bank stocks, it is probably safe to say that none of the 10 banks listed above will be offering dividends or increasing their dividends anytime soon, as doing so would drain more capital. In fact, these ten banks will probably look to shore up their capital to better withstand the Fed's scenario. Bank CD rates are currently on the low side with the exception of Ally Bank, so they should have room to increase their rates.

Ally Bank, the former GMAC Bank, has always offered some of the best CD rates compared to other bank's CD rates. These banks will probably start increasing their CD rates and savings rates to draw depositors so the banks can increase their capital. Don't expect rates to shoot up considerably since the FDIC has rate caps on all certificate of deposit terms that these banks must adhere too.

If you want to read more about the methodology of the test and the results you can read this report by the Board of Governers of the Redeal Reserve System: Bank Stress Tests
Author: James Martin
March 10th, 2013