Fed Releases Global Shock Stress Test Scenario for Big Banks

The Federal Reserve released “adverse and severely adverse” global financial market scenarios that will be used to gauge the strength of six large banks, as part of the central bank’s annual stress tests that will be finalized in March.

Six banks -- Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM), Morgan Stanley and Wells Fargo & Co. -- will have their portfolios tested to measure how they would do if the economy and financial markets experienced a severe downturn. The scenarios for the economy were released in November.

The U.S. central bank started stress tests in 2009 to restore confidence in the financial system after the worst crisis since the Great Depression brought down Bear Stearns Cos. and Lehman Brothers Holdings Inc. Regulators have since complemented the tests with a capital-planning requirement to improve boards’ management of risk and dividend and stock- buyback decisions.

“Supervisory stress test results will include data such as capital ratios, revenue, and loss estimates under a severely adverse scenario,” the Fed said today in a release in Washington. The parameters will include “a severely adverse scenario provided by the Federal Reserve, and reflect the capital actions the companies plan to undertake.”

March Release

The central bank will release results from supervisory stress tests at 4:30 p.m. on March 7 in Washington. Details about whether banks will be able to pay dividends or must build more capital, known as the Comprehensive Capital Analysis and Review, will be released at 4:30 p.m. on March 14, the Fed said.

The tests are designed to strengthen banks so they have enough capital to survive a financial crisis or recession. Bank stocks have climbed 23 percent in the past year for the best return among 10 industry groups in the Standard & Poor’s 500 Index. The overall index climbed 14 percent.

The scenarios released today contain data on global equity markets in dozens of countries and how much they might decline from an adverse shock. Banks must test, for example, against a 33 percent drop in equities in China, a 60 percent decline in Spain, and a 75 percent decline in Ireland.

The central bank previously released the economic scenarios in November. The worst of those parameters would test the bank against a recession in which U.S. gross domestic product declines by 6.1 percent and the unemployment rate climbs as high as 12.1 percent.

When the Fed released the scenarios last year, it said they were not forecasts and were “designed to assess the strength and resilience of financial institutions and their ability to continue to meet the credit needs of households and businesses.”

-- With assistance from Jeff Kearns in Washington. Editors: Gail DeGeorge, James Tyson

To contact the reporter on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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