The Federal Reserve on Wednesday announced guidelines for evaluating whether or not banks will be allowed to take actions that could result in a diminished capital base in 2011.

In other words, starting next year, banks will need to ask permission from the Fed before they can give money to shareholders through dividend payments or stock repurchases.

 

The purpose is to ensure that banks have enough money to keep afloat and lend to the American economy, even under adverse conditions.

 

Banks will be evaluated on their ability to absorb losses under several macroeconomic and business-model specific stress tests and meet the requirements of Basel III and the U.S. financial reform bill.  Before paying dividends, they must also first repay any outstanding U.S. government investments (like TARP).

 

Regardless of whether banks intend to pay dividends or not, they are encouraged to submit to the Fed their capital plans or profile for at least the next 24 months by Jan. 7, 2011. After that, banks are responsible for re-submitting their plans to reflect any changes in risk profile, business strategy, or corporate structure.

 

The Fed will also monitor banks' financial conditions relative to their plans, and if conditions prove to be significantly weaker than what is anticipated in the plan, management is expected to take steps to strengthen the capital base.

 

Email Hao Li at hao.li@ibtimes.com