Tuesday, November 22, 2011

New Tough U.S. Bank Stress Tests: Are They Really Going To Fail The Banks Tested?

It is being reported today that the Fed said  that the 31 largest U.S. banks will be stress tested for their loan portfolios and trading books against a "severe recession and a European market shock". The conditions are actually tough. Given that they may fail under less tough scenario, will they actually make all these banks fail?

The tests will assume:

  • 13 percent unemployment rate
  • 8 percent decline in U.S. GDP

 31 financial institutions are being asked to project revenues, losses and capital positions through the end of 2013 using four different scenarios, two provided by the Fed, and the other two defined by the bank. They take into account loan-loss reserves at the end of 2013.
Each Fed scenario for the U.S. variables includes five measures of economic activity and prices, four aggregate measures of asset prices or financial conditions and four measures of interest rates.
In addition, the six largest banks will also have their trading portfolios tested against a global market shock.
Seeing is believing.

Fed: “The aim of the annual capital plans, which build on the CCAR conducted earlier this year, is to ensure that institutions have robust, forward-looking capital planning processes that account for their unique risks, and to help ensure that institutions have sufficient capital to continue operations throughout times of economic and financial stress,”

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