By Lisa Lambert
WASHINGTON (Reuters) - Including funds that banks set aside to cover potential losses, known as capital buffers, in the annual stress tests that U.S. regulators administer to financial institutions would lead to big banks holding more capital, the federal office that monitors risks to the financial system said on Tuesday.
Each year, the largest banks such as Goldman Sachs <GS.N> and Wells Fargo <WFC.N> demonstrate in the tests how they would withstand crises of varying magnitudes and possibly undergo bankruptcy without using a federal bailout.
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In September, Federal Reserve Governor Daniel Tarullo said the central bank was considering factoring in capital buffers, which correlate to banks' sizes and are currently being phased in for U.S. institutions. All banks must keep at least one capital buffer, mid-sized banks two and the biggest banks that are considered important to the global financial system three.
The Office of Financial Research, which provides data and analysis to all U.S. banking regulators, found including the buffers for large banks in the stress tests "would result in the biggest U.S. banks holding more capital, all else being equal."
It noted the banks would not be allowed to hypothetically tap the buffers to pass the tests.
Meanwhile, "if buffers are not included in the stress tests, the tests could have a bigger impact on less systemic banks."
Because capital buffers are "needed most at the worst moments of economic turmoil," requiring the most influential banks to keep their buffers intact during stress tests "would make the financial system more resilient under extreme stress."
But, OFR added, it would also result in banks having to hold onto more capital during better times.
Federal regulators are looking into modifying stress tests and other requirements to ease up on small banks and create greater oversight of large ones.
Another possible change to the tests - assuming banks' lending would stop growing during times of severely adverse stress - could limit their capital available to extend new credit under stress, OFR said.
It also found that having a "static balance sheet" could overstate banks' resilience and would not take into account the risks posed by unplanned growth in their balance sheets, such as a loan pipeline backup.
(Reporting by Lisa Lambert; Editing by Alan Crosby)