On Friday the Salt Lake City-headquartered Zions Bancorporation (ZION) was found to have insufficient reserves to cover themselves in the event of financial catastrophe, failing a stress test administered by the Federal Reserve. Zions will be forced to shore up their reserves, shed their riskiest loans, and resubmit for approval.
These stress tests are designed to prevent another meltdown like the one the occurred in 2008 from ever again happening. The Federal Reserve’s stress tests however, which are conducted on every major and regional lender in the US, have to strike a tricky balance.
On one hand, the Fed can’t fail too many banks at once or get too byzantine with their punishments. They can’t just close the bank outright, leaving thousands of depositors in limbo. They also can’t flunk too many banks at once or they could threaten to jumpstart a panic.
At the same time the Fed cannot be too lenient in their stress tests. If they start rubber-stamping banks to try to avoid freaking out the populace, stress tests become purposeless.
So what happens to Zions after they fail the test? They are given a couple months to fix the problems by getting the riskiest mortgages off their books. They strengthen their reserves. And if they fail again, they can have their credit rating slashed, digging them further down the hole.
This is where Zion finds themselves. And it looks bad – of 30 major banks tested, they were the only ones to fail. But while they have failed the Fed’s stress test, they are getting a second chance. They will be continued to allow to operate even if they continually fail, which will certainly hurt them going forward and could make their situation dire, no matter what the macro conditions are.
Zion operates under the name Zion in Utah and Cal Bank and Trust in California. They have some $55 billion in assets and currently have a market cap of $5.84 billion.
By midday trading on Friday shares of Zions had fallen 4.30 percent to hit $31.57 a share.