Citigroup’s passing grade in stress tests is a vindication, even if the Fed has a soft touch

Citi has reason to cheer today.
Citi has reason to cheer today.
Image: AP Photo/Julie Jacobson
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UPDATE (5:55 PM ET):

Every U.S. bank except Ally Financial has passed the stress tests (pdf) conducted by the Federal Reserve under the Dodd-Frank banking reforms. Four banks failed last year: Citigroup, SunTrust, MetLife, and Ally. The bank formerly known as GMAC is still 74% owned by the US Treasury. It failed to meet the Fed’s rule that banks maintain high quality equity capital (common Tier 1 capital) equal to 5% of their risk-weighted assets, even if the economy goes down the toilet in the worst way imaginable.

Notably, the once-troubled Citigroup found that it would have high-quality capital equivalent to 8.3% of its assets in the “severely adverse scenario,” meeting all of the Fed’s requirements. That’s a vindication for Citi, which was Wall Street’s weakest surviving bank during the financial crisis. At one point, regulators held as much as a 40% stake in the firm, and that stigma—as well as still-tainted portfolio of bad assets—have weighed on the firm’s performance.

That’s not to say that Citi doesn’t still have its fair share of issues. A sprawling and expensive network of global operations has weighed on its earnings and share price. Nonetheless, today’s results will ease the minds of regulators, and increases the likelihood they will sign off on Citi’s request to return more capital to investors by buying back stock. Further, Citi’s passing grade will let CEO Michael Corbat finally move forward with plans to build and reshape the business, rather than focus on what one Citi executive reportedly called “the elephant in the room.”

That said, Citi still did not request to increase its dividend from the rock-bottom rate of $0.01, a move that it proposed and regulators denied a year ago. It’s not clear exactly why Citi didn’t make that request this year.

In general, today’s stress test results suggest that the US banking is in a much better place than it was even a year ago, and is continuing to keep up with the pace of economic reforms. US regulators have hiked the amount of capital banks have to keep on hand at all times with the hopes that they will be able to stay solvent even if they suffer big losses. But critics have argued that these stress tests aren’t stressful enough, particularly because they don’t look at some key data. Current US accounting rules allow banks to exclude their exposure to derivatives, a huge market of highly complex and interconnected trades. Without derivatives, stress tests may not be a true indicator of banks’ ability to weather a storm.

An earlier version incorrectly stated that Citi had requested a dividend increase.