Correction to This Article
This article about government regulators reviewing banks to see whether they are healthy enough to resume dividend payments incorrectly indicated that all of the largest U.S. banks eliminated dividends during the financial crisis of late 2008. Some major banks ceased paying dividends to shareholders at that time, but others merely reduced those dividends.

Review to show whether banks can pay dividends

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By Neil Irwin
Washington Post Staff Writer
Thursday, November 18, 2010

The nation's biggest banks will undergo reviews by regulators to establish whether their financial positions are solid enough to begin paying dividends again, as the banking sector tries to return to normalcy and its overseers try to gauge whether the time is right.

The Federal Reserve said Wednesday that it will use a "conservative" approach, applied equally across the 19 largest and most complex U.S. banks, to determine whether they should be allowed to pay their shareholders dividends, repurchase shares or take other actions that would reduce their buffers against future losses.

The reviews amount to a lower-profile version of the "stress tests" that regulators performed on the top banks in 2009, when officials sought to learn how much capital large firms would need to withstand worst-case-scenario economic conditions.

Fed officials say that effort taught them a lot about how to regulate banks in ways that reflect what is going on in the broader economy, lessons that will be used in the new reviews.

The largest banks ceased paying dividends to shareholders in late 2008, when their ability to survive came into question and government bailout money was pumped into the financial system.

Banks are eager to resume making payments to shareholders, but regulators don't want to take any chances that a major firm could again find itself undercapitalized if it suffers unexpected losses in a uncertain economy.

"We anticipate that some firms with high capital levels that have been retaining solid earnings for several quarters will be interested in increasing or resuming dividends," Fed Governor Daniel Tarullo said in a speech last week. "We will expect firms to submit convincing capital plans that demonstrate their ability to absorb losses over the next two years under an adverse economic scenario that we will specify, and still remain amply capitalized."

In issuing new guidance on the issue Wednesday, the central bank did not disclose the exact economic assumptions that will be used to calculate potential losses. The reviews are to be completed by Jan. 7, and banks will find out whether they have a green light to resume dividend payments in the first quarter of 2011.

Although major financial firms are in much better shape than they were two years ago, a range of risks remains.

In addition to the chances of a new economic downturn, they are facing new challenges in court from owners of mortgage-backed securities, claiming that banks should be held responsible for loans that went bad because they followed improper procedures. These are known as "put-backs," and a Fed official said Wednesday that the central bank is looking into potential losses from these claims.

"The Federal Reserve has been conducting a detailed evaluation of put-back risk to financial institutions," Elizabeth A. Duke, a Fed governor, said in congressional testimony Wednesday. "We are gathering information to ensure that the institutions we supervise have adequately assessed these risks and have accounted for them properly."

In his speech last week, Tarullo also specified that banks will need to show that they will be able to "comfortably" meet new international capital standards coming into effect even after paying newly instituted dividends, and that they will be able to handle any changes to their business strategy necessitated by the Wall Street reform legislation enacted this year.


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