Top U.S. banks told to stress test against severe recession

The Federal Reserve told the largest U.S. banks on Tuesday to test their loan portfolios and trading books against a severe recession and a European market shock.

The most severe point of the test will assume a 13 percent unemployment rate and an 8 percent decline in U.S. gross domestic product.

Some 31 bank-holding companies 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 bank.



All start in the fourth quarter of this year and go through 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.

The Comprehensive Capital Analysis and Review has become a centerpiece of the U.S. central bank’s heightened oversight of the largest banks. It is also an exam of decision making by bank 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 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,” the Fed said in a statement.

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 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 quarter of 2008, the Fed 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.

Bloomberg.com