Banks Are as Safe as Theyve Been in Modern Memory

By Markets Fool.com

Banks may not be doing great from a profitability standpoint, weighed down by interest rates that have been unprecedentedly low for almost eight years, but their balance sheets are as strong as they've been in modern memory.

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As John Maxfield and Gaby Lapera discuss in this week's episode of Industry Focus: Financials, the Federal Reserve's recently completed stress tests prove that the country's biggest banks are strong enough to survive even a worst-case economic crisis.

A full transcript follows the video.

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This podcast was recorded on July 25, 2016.

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Gaby Lapera:There's good news on stress tests for big banks!

John Maxfield:Yeah, the one thing to keep in mind is that while the banks are struggling right now from a profitability standpoint, so if you're looking at... I'm talking more about their income statement... From a balance sheet perspective, they're actually as safe as they have ever been, at least in modern memory, and that's because if you look back at the stress test, these banks are holding just an enormous amount of capital. What the stress test does is it makes up these hypothetical economic scenarios and then it tests to see what would happen to banks' businesses, and particularly their capital, basically how much money banks would lose under these economic scenarios.

In the most recent stress tests, the results of which were released last month, the economic scenario was basically the same as the financial crisis in 2008, put together with the 2011 sovereign debt crisis in Europe. Then they looked at "Would banks survive this economic scenario?" and "If they would, what would be the capital positions after going through this hypothetical gauntlet?" Even Bank of America, Citigroup, all of the big banks, had literally tens of billions of dollars in excess capital above the regulatory minimums, even after assuming they went through this horrible economic gauntlet that the stress test presumed. To your point, Gaby, while banks are struggling right now with this stagnant revenue situation, there's just no question that they're as safe as they've been in many, many decades.

Lapera:The other thing that I'd like to point out that the stress test tests for is having good internal controls and good risk management practices, which you obviously need in order to have all this capital on hand. All the big banks that we talk about regularly passed, so like JPMorgan, Wells Fargo, Bank of America. The only example that comes to mind... There's one other bank that failed and it was also on internal controls. It wasn't on capital and liquidity, but just on internal controls and governance stuff... It was a bank calledSantanderor, if you're my mother, BancoSantander. You're welcome, I'm so sorry, I was pronouncing it with my horrible American accent the last show. There was one other bank, I can't remember, but neither of them failed because they lacked capital or liquidity, it was because of internal controls. Everyone else passed with flying colors on all fronts.

Maxfield:Yeah, that other bank wasDeutsche Bank.

Lapera:Deutsche Bank, that makes sense.

Maxfield:Yeah, it's like European banks are just in a world of hurt right now, given everything that's going on.

Lapera:Deutsche Bank has been in a world of hurt partially of its own doing forawhilenow, like pre-Brexit it was not a pretty picture. Maybe another show we'll talk about Deutsche Bank.

Maxfield:Yeah, you're exactly right. In fairness to Deutsche Bank, it's not as bad as the Italian banks in terms of my understanding what's going on over there, but I think they're all... It's trading for a quarter of book value, 25% of book value, in or around there, is what I read just recently actually. If you think a quarter book value, that's like September of 2008, to put it in perspective over here.

Gaby Lapera has no position in any stocks mentioned. John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.