US banking giants face demands to bolster capital cushions

Government's 'stress test' set to tell 10 banks to raise money

More than half of the giant banks being "stress-tested" by the US government could be required to raise additional money to recapitalise the nation's financial system, survive a long recession and boost lending that will kickstart the economy.

With the results of the tests due to be published tomorrow evening, officials are continuing their final discussions with the 19 institutions. Several are believed to have argued the Treasury out of their original demands, but about 10 are still expecting to be told to raise money.

Ben Bernanke, the chairman of the Federal Reserve, one of the regulators working with the Treasury on the tests, said yesterday that repairing the banking system was vital if the early signs of economic recovery were not to be snuffed out.

Details of how the Treasury is calculating the requirement for a new "capital cushion" for the biggest banks have not been made public, leading to wild speculation on Wall Street, and the likely size of any fundraisings is also not clear. Some institutions' needs could run into many billions of dollars.

Three of the nation's four biggest banks by assets – Citigroup, Bank of America and Wells Fargo – are on the list of institutions originally told to shore up their balance sheet, according to leaks. Analysts also expect some regional banks to have to fill holes which may open up in their accounts if business loans and mortgages go bad in a prolonged recession.

Mr Bernanke was on Capitol Hill yesterday testifying to the joint economic committee of Congress, where he painted an optimistic picture of the US economy. While a recovery would be slow, with unemployment likely to continue to increase and then stay high for a long while, there were tentative signs of stabilisation, led by consumer demand.

"An important caveat," the Fed chairman said, "is that our forecast assumes continuing gradual repair of the financial system. A relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall."

The Obama administration launched the stress tests in February as one part of its plan to repair confidence in the banking system. Other initiatives included public loans to private business to revitalise the securitisation market and to buy up toxic assets from distressed banks, plus relief for homeowners facing foreclosure.

The tests are designed to forecast banks' likely financial results and capital positions under a long recession, with unemployment peaking above 10 per cent next year. Bank executives and employees have criticised the methodology, while bearish economic forecasters have said they are not tough enough and are designed to protect the biggest banks from nationalisation.

The government says that banks will have six months to raise private capital but, if they cannot, then they must take US taxpayer money. That could make the government one of the largest shareholders in the nation's largest banks.

Bank shares, however, have surged as the results of the tests draw nearer, suggesting optimism among investors that the health of the financial system may not be as dire as once predicted.

Mr Bernanke, meanwhile, defended the stress tests from Congressional criticism that banks are being given too long to appeal against the capital rulings, which were revealed to them privately more than a week ago. The results had been due to be made public on Monday this week.

"This was a very comprehensive exercise, unprecedented in its scale and scope," Mr Bernanke said. "The three federal oversight agencies collaborated very closely, working through the entire portfolios, the reserves and practices and the earnings of the 19 largest banks in the country. After we completed our first set of data we took the data back to the banks and we gave them an opportunity, not to negotiate, but to point out where there were misunderstandings and communication problems."