When you hear the term “stress test”, banking is the last thing that comes to mind. In the past, people think of it together with a heart monitor, the treadmill, and physical exams. But the words “stress test” has a totally new meaning these days. It has become associated with banking and finance as the government tries to determine how strong the nation’s largest banks are in coping with the financial crisis.
Shortly after taking office, President Obama has already placed the stress test as one of his top agendas. According to the NPR published back in February, the stress test is an accepted method to know how resilient a bank is based on its balance sheet. Essentially, it uses “computer models based on historical data to judge how it would withstand various hypothetical situations”.
Which Banks are mandated to take the Stress Test?
The Obama administration requires all US banks to undergo the stress test if they have assets of more than $100 billion. The total number of banks that fall into this category is 19. Essentially, each will be hypothetically “shocked” with scenarios ranging from home prices falling by 25 percent more to unemployment levels hitting 10 percent or more. The stress test is specifically designed to ensure that the country’s major banks can survive and even continue lending in worst case scenarios.
However, although the Obama administration has said that distressed financial institutions will need to raise more capital to meet the set standards, the government also disclosed that it is ready to help. Some economic experts have said that this follows the current administration’s belief that certain banks are just “too big to fail”. The 19 major banks have about half the loans in the United States financial system. These institutions will play a significant part in economic recovery.
The government’s willingness to help echoes its philosophy that major banks need to be rescued. The Federal Reserve is ready to use several tools that will help improve a bank’s financial health. Notable methods include converting Treasury loans into shares of stocks, compelling financial forms to raise capital from private markets, and government-backed merger as in the case of Bank of America and JPMorgan Chase.
When Will The Results Be Released?
Depending on your current situation, the results of the stress test can have a direct or indirect effect on you. Senior Fed officials held top-level meetings with bank executives to discuss their situation. The Federal Reserve has assured the public that it will keep an eye on the banks to ensure that they will be able to meet their obligations. Currently, the results of the stress test are tentatively set to be released on May 7th. Most, if not all, the 19 banks are expected to pass the stress test. Banks with better financial health will be rated higher than others.
