Feb. 11 (Bloomberg) -- The Federal Reserve and the Office of the Comptroller of the Currency will have new power to determine the fate of U.S. banks, under the Treasury’s financial-rescue plan.

The two regulators will put the banks through stress tests in the coming months to determine if they have adequate capital to survive more unforeseen economic crises. Should the banks come up short, they will be ordered to raise money, accept a government cash infusion that comes with conditions, or perhaps be shut down, according to the plan.

“The stress test is critical,” said Peter Sorrentino, who manages $16 billion at Huntington Asset Advisors in Cincinnati. “Depending on how you set that up, some of these banks aren’t going to be ongoing concerns.”

Banks that are likely to undergo the additional scrutiny include the nation’s largest, including JPMorgan Chase & Co. and Citigroup Inc., as well as smaller lenders such at SunTrust Banks Inc., Fifth Third Bancorp, and PNC Financial Services Group Inc., according to the American Bankers Association.

The requirement is part of a broader plan laid out by Treasury Secretary Timothy Geithner yesterday to pour as much as $2 trillion into efforts to spur lending and address banks’ toxic assets, and end the credit crunch hobbling the economy. His proposal includes a joint public- and private-sector fund to buy as much as $1 trillion of illiquid assets and a $1 trillion program to supply credit to consumers and businesses.

Geithner, 47, will use what remains of the $700 billion financial-rescue fund that Congress authorized in October.

Sketchy Details

The details of the program remain sketchy. Geithner declined to say during a Senate hearing yesterday whether he would allow any of the 18-20 banks with more than $100 billion in assets to fail if they are undercapitalized and unable to raise new money.

“We will take whatever action necessary to help prevent the kind of failure that would cause systemic damage to our system,” he said in response to a question from Senator Jon Tester, a Montana Democrat.

When Tester asked if that meant the institutions are “too big to fail,” Geithner said, “I don’t think, senator, I’d want to use those words.”

The stress tests are aimed at ensuring the survival of the lenders and restoring stability to the banking system, where illiquid assets have weighed down balance sheets, undermined investor and consumer confidence and led banks to stop lending.

Fed, OCC

To carry out the tests, the Treasury tapped the Federal Reserve, which oversees bank holding companies and some state- chartered banks, and the Office of the Comptroller of the Currency, a Treasury agency that regulates more than 1,500 banks, including units at Citigroup and Bank of America Corp.

One former regulator said the requirement doesn’t give the agencies any authority they didn’t already have.

“The agencies pretty much have carte blanche in regard to authority over financial institutions,” said Gilbert Schwartz, a former Fed counsel who’s now a partner at the law firm of Schwartz & Ballen in Washington. “They say ‘jump’ and the institutions say ‘how high?’”

Still, Wayne Abernathy, executive vice president of the Washington-based American Bankers Association, says this scrutiny is different.

“This is not a normal stress test,” said Abernathy. “These banks already have resident examiners. They have sheriffs in their offices every day. The new test is to ask what if the unforeseen happens?”

Lost Faith

Investors have no faith in banks’ own reporting of their financial health, said Jeffrey Ng, a capital-markets expert at the Sloan School of Management at the Massachusetts Institute of Technology in Cambridge, Massachusetts.

“Even when banks report positive numbers, investors still have little confidence that these assets have any significant value,” Ng said in a statement.

Four months after the government’s $700 billion bailout program was established, investors are demanding a 5.20 percentage-point premium over U.S. Treasuries to buy bonds sold by companies with investment-grade ratings, more than five times the level of two years ago.

The Treasury, Fed and other supervisors in the President’s Working Group on Financial Markets will develop guidelines for the bank examinations, which are aimed at ensuring the country’s largest banks can withstand a weakening economy.

More Stress

“If the economy continues on its trajectory right now, it’s going to put a lot more stress on institutions, and there will be significantly more losses,” John Dugan, the head of the Office of the Comptroller of the Currency, said in a Feb. 2 interview. The OCC is charged with closing failed banks it oversees, and has shuttered two of the nine banks that have collapsed this year.

Under the Treasury plan, banks with insufficient capital may be given more taxpayer funds in the form of convertible preferred securities.

The tests “will allow supervisors to determine whether an additional buffer, particularly one that strengthens the composition of capital, is needed for the bank to comfortably absorb losses,” according to a joint statement by officials including Geithner, Fed Chairman Ben S. Bernanke, Dugan and Sheila Bair, chairman of the Federal Deposit Insurance Corp.

To contact the reporters on this story: To contact the reporters on this story: Alison Vekshin in Washington at avekshin@bloomberg.net; Alison Fitzgerald in Washington at afitzgerald2@bloomberg.net.

Last Updated: February 11, 2009 00:01 EST