Fed Unveils Bank Stress-Test Methodology

On April 24^th, the Fed released the methodology used to determine the financial stability of the 19 largest banks in America. These stress tests are intended to breakdown the health of the banking industry and calculate which banks have enough capital to withstand any further deterioration of the economy.

The stress tests were broken out into two different economic scenarios. The first model is based on the current projects using a national unemployment rate of 8.8% as well as the consensus of economic experts’ predictions for the next year. The second model was based on a worse than expected scenario and a national unemployment rate of 10.3%. Other factors that were included in these stress tests include gross domestic product and the housing market.

Banks have been meeting with Fed representatives over the last two months to determine the expected profits, losses and levels of capital in the two different scenarios. While the methodology was released a few days ago, the full results are not expected to be made public until early May. In the meantime, banks will review and potentially challenge the results of the tests.

Regulators have been cautious to warn investors that these results should not be used as a definitive guide as to which banks are doing well. It was recently leaked that Bank of America and Citibank will need to raise more capital based on these tests; these results are already in the process of being rebutted and appealed. All in all, it seems that these stress tests are intended to bolster consumer confidence in the health of the banking sector, not truly providing a measure of economic stability. The Fed regulators are singing one tune about how banks need more capital, and the banks are saying that they are sufficiently leveraged against today’s economic climate. Who to believe? I wish I knew.

If you are interested in the full details of the methodology, you can find it here.

Update:

Regulators have delayed the release of the results of the stress test until May 7th. Originally scheduled for release on May 4th, the cause of the delay is suspected to be the banks’ dispute with the results of the test. We’ll check back in on this when the results come out, or update you if there are additional delays.