Bank stress test

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A stress test refers to an analysis done by a bank or financial institution to determine its viability during certain adverse economic conditions.

In early 2009, the U.S. Treasury applied “stress tests” for banks under the Obama Administration's Capital Assistance Program. The stress tests gauge the capacity of banks with more than $100 billion in assets to weather a downturn under a scenario in which unemployment rises above 10 percent next year and house prices fall by 27 percent over two years. Financial companies will have to raise more funds from the government if needed. The state may end up owning majority stakes in some banks.[1] In May 2009, Treasury Secretary Tim Geithner announced the results of the stress tests: Ten banks, including Bank of America, Citibank, and Wells Fargo, must collectively raise $75 billion in extra capital by November, Geithner said. The rest of the banks are fine.

Section 165 of the Dodd-Frank Act called for prudential regulators including the Federal Reserve, FDIC and Office of the Comptroller of the Currency to create a framework for banks with assets over $10 to conduct annual stress tests.[2] In October 2012, the three regulators published their final rulemakings related to Section 165.

Recent News

On Tuesday, October 9, 2012, two regulators, the FDIC and Federal Reserve Board, approved regulations that required more than 100 large financial institutions with over $10 billion in assets to conduct annual stress tests in order to determine whether or not they had enough capital in the event of a deep recession. Proposed in January of 2012, the rule gave a break to mid-sized banks, giving them two additional years before any test results are made public. [3] Also on October 9, 2012, the final stress test rules from the Office of the Comptroller of the Currency (OCC) were published in the Federal Register. The OCC rules, which cover national banks, federal savings associations and federal branches of foreign banks, mirror those of the FDIC and Fed rules.

In May of 2010, the European Union's Committee of European Banking Supervisors (CEBS), a small umbrella entity for all of the EU's national regulators, oversaw a transparent stress test on 91 of their biggest banks. The tests currently focus on capital stress and whether a bank is solvent, not on liquidity and whether the bank can run it's day to day operations. According to the Financial Times, the CEBS is trying to change that.

On Friday, July 23, 2010, the tests results revealed that seven out of the 91 banks failed including; Germany's lender, Hypo Real Estate Holding AG, five unlisted Spanish savings banks and Greece's ATE. [4] The banks needed above tier one capital ratio to pass and the seven banks were short 3.5 billion euros. The CEBS deemed their capital insufficient if there was a steep fall in the price of government bonds many of them hold. Shortly afterward, these banks began capital raising exercises.

Geithner was quoted in the Financial Times saying that the EU had made "significant effort to increase disclosure on the conditions of individual European financial institutions and enhance market stability." However, investors are hesitant about the results and question the low number of banks that failed the test. [5]

In the 2014 audit of eurozone banks by the European Central Bank, 13 out of the 130 big banks under review failed the stress tests.

References

  1. The stress test mess. The Economist.
  2. Mid-Sized U.S. Banks Have Another Year Before Stress-Testing. Bloomberg.
  3. U.S. approves stress test rules for 100 banks. The Wall Street Journal.
  4. Seven of 91 banks fail European stress tests. MSNBC.
  5. European banks gain confidence boost as only seven fail stress tests. Financial Times.