Fed to Test 19 Banks’ Capital Against Recession Scenario

The Fed is going to give stress tests to 19 banks and test to see if they would make it through a deep recession and a second housing crisis. The results of these tests will come out on March 15. These tests are critical to prevent another bank collapse like that of Lehman Brothers.

By Craig Torres
Mar 12, 2012 3:06 PM MT

The Federal Reserve will show how the capital of 19 U.S. banks might fare through a deep recession and a second housing crisis when they unveil stress-test results in three days.

The tests will show results for revenues, capital ratios and profits or losses at each firm over a nine-quarter period, the Fed said in a paper released today in Washington. The results will be released at 4:30 p.m. on March 15. Templates included in the Fed release today showed an array of categories it plans to disclose, from trading and counterparty losses to credit cards and first-lien mortgages.

“Strong capital levels are critical to ensuring that banking organizations have the ability to lend and to continue to meet their financial obligations, even in times of economic difficulty,” the Fed said in a statement. “The supervisory stress scenario is not the Federal Reserve’s forecast for the economy, but was designed to represent an outcome that, while unlikely, may occur if the U.S economy were to experience a deep recession at the same time that economic activity in other major economies contracted significantly.”

The KBW Bank Index of 24 U.S. lenders has advanced 15 percent this year as investors bet a strengthening economy will help firms boost earnings. Concern that the nation’s banks may be damaged by Europe’s debt crisis helped drive down the index 25 percent in 2011, its worst annual performance since the 2008 credit crisis.

Lehman Brothers Collapse

Stress tests date back to 2009, when supervisors tried to determine the extent of losses facing the nation’s largest lenders following the collapse of Lehman Brothers Holdings Inc. (LEH) and the subsequent financial crisis. Gross domestic product contracted at an 8.9 annual rate in the fourth quarter of 2008.

For the current test, the Fed provided the banks with 25 variables, including estimates on gross domestic product, Treasury bill rates and indexes of consumer prices and home prices. The more severe scenario assumes an 8 percent drop in U.S. gross domestic product, an unemployment rate as high as 13 percent and a 21 percent drop in home prices.

Six banking-holding companies with large trading, private equity and derivatives activities were also subjected to tests of these positions from a “global market shock,” the Fed said. The six banks are Citigroup Inc. (C), Bank of America Corp. (BAC), Wells Fargo & Co., Morgan Stanley, Goldman Sachs Group Inc. (GS), and JPMorgan Chase & Co. (JPM)

The Fed said it estimated revenue and losses under the stress scenario based on detailed data provided by the firms and verified by supervisors. The Fed said the tests draw on the expertise “of hundreds of staff,” including supervisors, economists, and market analysts.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

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