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Digging Deeper into Fed’s Stress Tests

Piggy Bank 2 BHWith concern in the industry growing over whether or not the largest financial institutions can withstand an economic downturn, the Federal Reserve is about to let the industry know just how well capitalized those institutions are as they do annually.

The Fed will release the results of its two annual supervisory stress test exercises later this month—the Dodd-Frank Act Stress Tests (DFAST) on Thursday, June 23, and the Comprehensive Capital Analysis and Review (CCAR) on Wednesday, June 29. The results of both exercises will be released on 4:30 p.m. EST on their respective days.

The Fed and the FDIC in April jointly rejected the “living wills” (plans as to how banks would enter bankruptcy without causing widespread damage to the U.S. financial industry) of five banks—Bank of America, Bank of New York Mellon, JPMorgan Chase, State Street, and Wells Fargo—which again revived the debate over whether “Too Big to Fail” still exists.

The CCAR will test 33 bank holding companies with $50 billion or more in total consolidated assets. For the 2016 cycle, the CCAR will include a severely adverse global economic scenario in which “U.S. unemployment rate rises five percentage points to 10 percent, accompanied by a heightened period of corporate financial stress and negative yields for short-term U.S. Treasury securities,” according to the Fed.

The DFAST is a complementary exercise to the CCAR that will “help assess whether institutions have sufficient capital to absorb losses and continue operating during stressful economic and financial conditions over a period of nine quarters. The results of the tests conducted by Federal Reserve supervisors will include data such as projected post-stress capital ratios, revenue, expense, and loss estimates under hypothetical adverse and severely adverse scenarios previously published by the Federal Reserve,” according to the Fed.

While they both fall under the category of “supervisory stress tests,” the DFAST and the CCAR are quite different, according to the Fed.

“While DFAST is complementary to CCAR, both efforts are distinct testing exercises that rely on similar processes, data, supervisory exercises, and requirements,” the Fed stated. “The Federal Reserve coordinates these processes to reduce duplicative requirements and to minimize regulatory burden.”

Earlier in June, two Fed governors announced that the capital requirements for banks would be tougher for this year's round of stress tests. Fed governor Daniel Tarullo said that the tougher requirements include “a significant increase in capital.” Fed governor Jerome Powell said that he hopes the new requirements will “fully internalize the risk” their size poses to the economy and that he has “not reached any conclusion that a particular bank needs to be broken up or anything like that.” Instead, Powell said the Fed will “raise capital requirements to the point at which it becomes a question that banks have to ask themselves.”

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

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