Stress Test For Banks — Revealed!

Banking regulators finally revealed the “stress tests” that they will use to measure whether a bank is sufficiently capitalised to operate without further capital injections. 

To explain the stress tests the Federal Reserve released a Q&A. The entire document is below. Here are some quick notes:

  • Tests a baseline and an adverse case looking two years into the future.
  • Uses three metrics: GDP, Unemployment and Housing Prices.
  • Baseline case 2009: -2.0% GDP, 8.4% unemployment and a 14% decline in housing prices.
  • Adverse case 2009: -3.3% GDP, 8.9% unemployment and a 22% decline in housing prices.
  • Baseline case 2010: +2.1% GDP, 8.8% unemployment and a 4% decline in housing prices.
  • Adverse case 2010: +0.5% GDP, 10.3% unemployment and a 7% decline in housing prices.

The big questions will be whether these measures are adequate to realistically test the financial health of banks and whether the adverse case is adverse enough to account for a possible severe downturn. Also, will the recession really have pulled back as strongly and housing market declines slowed as much as the Fed expects in 2010? We’ll most certainly dig into these questions. But let us know what you think.