Picture it: The U.S. is hit with another financial crisis.
The recent improvements in the U.S. housing market? Quickly reversed. Instead, housing prices plunge by 25 percent. As the country careens into a deep recession, the unemployment rate jumps 4 percentage points from its current levels and continues to skyrocket, hitting 11.25 percent.
Meanwhile, Europe is having its own recession struggles. Conditions are weakening in Asia. Japan slips into a recession. ...
OK -- by now, are you hyperventilating a bit? Don't worry: This scenario is not a prediction of the near future, but instead is a hypothetical storyline the Federal Reserve used for its most recent stress tests of big banks.
'This is only a test'
The Dodd-Frank Act stress test (DFAST), the results of which were just released, uses hypothetical situations to look at 30 banking companies with $50 billion or more in assets and measures how well those banks would be able to weather a major economic downturn.
The tests are meant to determine whether the companies have adequate controls and buffers in place so they wouldn't need a government bailout come troubling times.
The latest results show that the banks are "collectively better positioned to continue to lend to households and businesses and to meet their financial commitments in an extremely severe economic downturn than they were five years ago," the Fed says in a statement. Still, it notes that some of the banks would suffer massive losses under the most severely adverse scenario.
Zions Bancorp came in at the back of the pack in the tests, reporting just 3.6 percent "Tier 1 capital" -- which is Fed-speak for cash and other liquid assets. In a second, similar stress test, the Fed considers 5 percent the minimum capital ratio for a bank to be well capitalized.
Other banks fared better. Leading the group of 30 were State Street, with a 13.3 percent Tier 1 common capital ratio, and Bank of New York Mellon and Discover Financial services, with ratios of 13.1 percent and 13.2 percent, respectively.
Banks can't pass or fail this test. However, that second stress test that I mentioned, called the Comprehensive Capital Analysis & Review (CCAR) and being released March 26, will have minimum capital ratios that banks will be expected to meet. The CCAR takes into account banks' capital action plans -- how they use their capital, such as for dividend payments, stock repurchases or planned acquisitions.
No one stressing at the Fed
"The annual stress test is one of the Federal Reserve's most important tools to gauge the resiliency of the financial sector and to help ensure that the largest firms have strong capital positions," Federal Reserve Governor Daniel K. Tarullo says in a news release. "Each year we are making substantial improvements, which have helped make the process even stronger than when we first conducted the stress tests in the midst of the financial crisis five years ago."
The American Bankers Association also lauded the results, saying in a statement that "regulators threw every economic calamity they could think of at our nation’s largest banks, and these institutions once again proved their ability to handle even the most extreme financial distress."
Are you a customer of a big bank? Are you heartened by this stress test?
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