Stress Tests for Stressed-Out Banks To Hurt More

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Bank of America

The Federal Reserve made the market uneasy with its decision to rope in 12 additional banks to its list of financial institutions that will be subject to its annual regulatory stress tests. [1] The 31 banks on the list, including the subsidiaries of banks headquartered overseas, meet the Fed’s criteria of having total assets of more than $50 billion on their books. All these banks are required to detail the impact of a series of rather adverse economic situations – both domestic and international – on their businesses. The results of these stress tests will serve as a benchmark for the Fed to determine steps to strengthen the country’s banking industry. While the motive behind the stress tests is sound, the 6 largest banks – Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM), Goldman Sachs (NYSE:GS), Citigroup (NYSE:C), Morgan Stanley (NYSE:MS) and Wells Fargo (NYSE:WFC) – would dread the Fed’s directive of a comprehensive Europe-focused stress test for them, as this could lead to them having to raise more capital in these troubled times.

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Bank of America | JPMorganGoldman SachsCitigroup | Morgan Stanley | Wells Fargo

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The stress tests include subjecting the banks to scenarios like unemployment rates of 13% in the U.S. and an 8% decline in the country’s GDP figures, which the Fed maintains are not very far what was witnessed during the economic downturn of 2008. [2] The banks are required to furnish the results to the Fed by early January of next year and will receive directives on the next steps by mid-March.

The 6 largest banks have been singled out by the Fed for their significant exposure to the European economies as a part of their large sales and trading operations. These banks will also have to include tests that gauge the impact of a collapse in key European economies on their operations.

However, the tests can lead to larger repercussions for banks next year, as the regulatory body will likely make considerable changes to the banks’ capital plans. Banks are already expecting the Fed to keep a closer watch on their coffers by disallowing dividend payouts and share repurchases. But the stress test results may actually lead to the Fed forcing the banks to raise additional capital – a task which will cost the banks a lot given the weak economic conditions.

Bank of America, with its already mounting capital concerns, is expected to be hit the hardest by any such directive by the Fed.

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Notes:
  1. U.S. banks facing 2012 Fed stress test, Reuters, Nov 23 2011 []
  2. Fed to test six big banks for Euro stress, Reuters, Nov 24 2011 []