Large financial institutions facing
their annual round of stress tests were given their scripts by regulators on
Friday. The tests are designed to
identify ways these complex institutions might react to severe stress in the
national and world economies. The Office
of Comptroller of the Currency, Federal Reserve Bank and the Federal Deposit
Insurance Corporation are looking for indications of forward looking capital
planning processes and whether the institutions have sufficient capital to
continue operations during critical periods.
The information will be used by
the agencies for bank supervision.
The scenarios involve a set of baseline,
adverse, and severely adverse scenarios against which the institutions must
test their level of preparedness. Large
financial institutions with consolidated assets in excess of $10 billion are
required, under a mandate of the Dodd Frank Wall Street Reform and Consumer
Financial Protection Act to participate.
This year 30 banks will take the tests, an increase of 12 from last
Each of the three scenarios include 28
variables including economic activity, unemployment, exchange rates, prices,
incomes, and interest rates. The Fed says
the adverse and severely adverse scenarios are not forecasts but rather
hypothetical situations designed to assess the strength and resilience of the
participants which are divided into $10 billion to $50 billion and over $50
billion classifications. Scenarios will
be the same for both groups.
Each of this year's scenarios examine
how the biggest banks might react to jump in long-term interest rates and
another housing crash over which are layered other factors such as high
unemployment, or a slowdown in Asian economies. The intensity of the various factors are
manipulated in accordance with the severity of the scenario.
For example, under the baseline scenario the country shows
moderate economic expansion; real GDP growth accelerates while unemployment
edges down and interest rates remain flat in 2014. Then short term Treasury rates increase
steadily, reaching nearly 2.5 percent by the end of 2016. Home equity and property prices would
appreciate modestly through 2016 while economic activity, inflation, and
exchange rates outside the U.S. expand but with divergent growth patterns.
scenario is characterized by a substantial weakening in economic activity
across all of the economies included in the scenario, a significant reversal of
recent improvements to the U.S. housing market and the euro area outlook. There
will be a sharp slowdown in developing Asian economies as a proxy for severe
weakening everywhere. The larger decline
in U.S. house prices in this scenario is viewed as particularly relevant for localities
that have experienced brisk gains in house prices over the past year.
Along with the scenarios the regulators
released the final "Policy Statement on the Principles for Development and
Distribution of Annual Stress Test Scenarios." The guidance outlines the
consultative processes regulators will use to gather information on the
institutions' material vulnerabilities and to coordinate with each other to
develop the scenarios each year. Under
rules finalized last year OCC must provide the required scenarios by November
15 of each year.