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On Monday, the Federal Reserve came up with the approval for re-submitted capital plans of The Goldman Sachs Group, Inc. (GS - Analyst Report) and JPMorgan Chase & Co. (JPM - Analyst Report). Though previously Goldman and JPMorgan received the Fed’s approval for their proposed capital plans during the 2013 Comprehensive Capital Analysis and Review (CCAR), these banking stalwarts were asked to resubmit the plan by the end of third-quarter 2013, considering the weaknesses recognized in their capital planning processes.

Therefore, the Fed’s approval signifies the financial stability of these banks and their capital adequacy.

Background

Currently authorized under the Dodd-Frank financial-services law, the stress tests were first introduced after the 2008 financial crisis. During this economic downturn, big financial institutions like Lehman Brothers collapsed and several other big banks including JPMorgan and Citigroup Inc. (C - Analyst Report) were on the verge of a collapse. This compelled the U.S. government to infuse billions of dollars into credit markets and save the entire financial system from crumbling.

Among the 18 bank holding companies which submitted their capital plan to the Fed in Jan 2013, the auto lender, Ally Financial, majority-owned by U.S. taxpayers was the only bank which failed to meet the minimum requirement of 5% Tier 1 common capital ratio.

Apart from Ally, BB&T Corporation’s (BBT - Analyst Report) capital plan had been rejected by the Fed based on certain “qualitative” grounds.

However, both these banks resubmitted their capital plans with the Fed. Notably, BB&T received the approval in August, while Ally’s plan was approved last month.

On the Path to Recovery

This, however, is not the end. The big banks will have to undergo the Fed’s stress test once every year. These would help build up the weak capital levels of banks, which are a looming threat to the economy. Also, this could ultimately translate to less involvement of the taxpayers’ money for bailing out troubled financial institutions.

However, the government needs to etch out certain policies to ensure that every industry participant contributes to the overall profitability. While the bigger banks benefited greatly from the various programs launched by the government, many smaller banks are clambering to catch up.

The banking sector presented a better picture in 2013 compared to 2012. Improved economic data such as higher consumer spending and GDP, improving housing market and declining unemployment rate point towards optimism, but the current low-rate environment and an expected increase show a bumpy road map toward growth.

Though economic uncertainty still lingers, banks are actively responding to every legal and regulatory pressure. In fact, this has positioned the banks well to encounter impending challenges. As the sector’s structure is undergoing a radical transformation, it is expected to witness headwinds in the near to mid term. However, entering the new capital regime will significantly improve the industry’s long-term stability and security. We look forward to CCAR 2014 results, which are expected in Mar 2014.

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