Please ensure Javascript is enabled for purposes of website accessibility

Capital Requirements of Goldman Sachs and Morgan Stanley Slightly Lowered After Fed's Mistake

By Bram Berkowitz - Sep 4, 2020 at 3:36PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The Federal Reserve said it made an error when calculating trading losses, resulting in Goldman and Morgan seeing different capital ratio requirements.

Both Morgan Stanley (MS 1.47%) and Goldman Sachs (GS 1.08%) will see their regulatory capital requirements reduced slightly after the Federal Reserve identified an error in its stress test calculations.

The Fed said in a statement that an error was made while projecting trading losses, not properly calculating losses for "certain public welfare investments" made by some of the largest banks.

The Fed said five banks were impacted by the error, including Citigroup (C 1.52%), Wells Fargo (WFC 2.08%), and HSBC (HSBC 0.63%). But the error only resulted in capital requirement changes for Morgan Stanley and Goldman Sachs.

Required Capital Ratios

Image Source: Federal Reserve

As you can see above, the error impacted the required common equity tier 1 (CET1) capital ratios of Morgan and Goldman. Closely watched by regulators, the CET1 measures a bank's core capital as a percentage of its risk-weighted assets and serves as a buffer against unexpected loan losses.

Although the changes are small, they can make an impact because these banks hold hundreds of billions in assets. The less regulatory capital banks have to hold, the more they can deploy into assets and securities that generate returns.

Every year, the Fed conducts stress testing, where it projects how the balance sheets of certain banks would fare under hypothetical and typically adverse scenarios categorized by falling GDP and rising unemployment.

This year's stress testing was closely watched by investors because the coronavirus pandemic made some of these once hypothetical scenarios more of a reality. As a result, the Fed ran additional sensitivity analyses to determine how banks might hold up in certain pandemic-related scenarios.

As a result, many banks saw their CET1 ratios requirements increase. No bank saw larger increases than Goldman, whose required CET1 ratio increased from 9.5% to 13.7% before the error, and Morgan Stanley, which saw its required CET1 requirement rise from 8.6% to 13.4% before the error.

The changes are good news for Morgan Stanley, which already was well clear of its required threshold with a 16.1% CET1 ratio at the end of the second quarter. The news will also be welcome by Goldman, who was at a 13.6% CET1 ratio at the end of the second quarter, putting it right on the threshold. Banks that see their CET1 ratios fall below their required minimums can face limits on their capital distributions.

This is not the first time the Fed has had to correct errors in its stress testing. The Fed made an error on its calculations in 2012, according to The New York Times , and in 2019 . But neither impacted banks' capital requirements after the Fed had already issued them.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
$54.00 (1.52%) $0.81
The Goldman Sachs Group, Inc. Stock Quote
The Goldman Sachs Group, Inc.
$351.68 (1.08%) $3.77
Morgan Stanley Stock Quote
Morgan Stanley
$90.20 (1.47%) $1.31
Wells Fargo & Company Stock Quote
Wells Fargo & Company
$45.25 (2.08%) $0.92
HSBC Holdings plc Stock Quote
HSBC Holdings plc
$33.50 (0.63%) $0.21

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/12/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.