The Federal Reserve told the 31 largest U.S. banks to test their loan portfolios and trading books against a deep recession and a European market shock.
The test’s severest point will assume a 13 percent jobless rate and an 8 percent decline in U.S. gross domestic product. Bank holding companies with assets of $50 billion or more are being asked as part of their 2012 capital plan review to project revenues, losses and capital positions through the end of 2013 using four different scenarios, two provided by the Fed and two defined by the banks.
The Comprehensive Capital Analysis and Review is a centerpiece of the U.S. central bank’s heightened oversight of the largest lenders. It is also an exam of decision-making by the firms’ management and boards. The Fed is assessing how well they understand their risks and demands on earnings and capital from new standards coming from both international accords and the Dodd-Frank act in the U.S.
The aim “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,” the Fed said in a statement.
The reviews will extend from the fourth quarter of 2011 until the last quarter of 2014, taking 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. The six largest banks will also have their trading portfolios tested against a “global market shock,” the Fed said. It said the scenarios don’t represent its outlook for the economy.
The decision to make the scenario public before the tests began marks a step toward greater transparency in supervision by the Fed. The central bank didn’t disclose the scenarios when it started its 2011 stress tests in November last year. The Fed completed those tests in March.
The Fed said it would approve dividend increases and other capital distributions “only for companies whose capital plans are approved by supervisors and are able to demonstrate sufficient financial strength to operate as successful financial intermediaries under stressed macroeconomic and financial market scenarios, even after making the desired capital distributions.”
The 24-stock KBW Bank Index, which includes shares of companies such as Bank of America Corp., Northern Trust Corp., and Capital One Financial Corp., is down 31 percent for the year versus a 5.5 percent decline for the Standard and Poor’s 500 Index.
The Fed will also publish the results of the tests for the 19 largest bank holding companies. Six institutions with large trading operations will have to estimate potential losses from a hypothetical “global market shock,” the Fed said. That shock will be based on market price movements seen during the second half of 2008, it said, and include a scenario involving “sharp market price movements in European sovereign and financial sectors.”
The Fed said it would publish the results of the market shock scenario of the six institutions.
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