markets

Wall Street Faces Fed Stress Tests That Assume Another Meltdown

  • Big banks to be judged in regulator’s hypothetical disasters
  • Tests may soon get significantly easier for U.S. lenders

Wall Street banks must prove they are able to weather a serious global recession as part of an annual Federal Reserve exercise meant to ensure the biggest lenders won’t collapse in a new crisis.

The stress test scenarios released Thursday by the Fed will be used to figure out whether 18 firms including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Deutsche Bank AG are sufficiently sturdy to handle a significant blow to the economy. Good performance could mean banks are given more leeway to pay dividends to shareholders and buy back stock.

The worst of the newly released hypothetical scenarios feature a jobless rate that climbs to 10 percent -- rivaling the level seen during the crisis a decade ago -- and a dramatically steepening yield curve in Treasuries. The Fed stress tests for the first time include several foreign banks with U.S. operations. Another 20 smaller, less complex firms will face an easier version of the exams, though the scenarios they will be subjected to are the same.

Banks Buckling

The Fed wants banks banks being subjected to the exercise known as the Comprehensive Capital Analysis and Review to submit their plans for distributing capital by April 5. The results of the tests will be announced by June 30, though the exact date hasn’t yet been set.

The stress tests, which were introduced after the 2008 financial crisis, have driven capital levels higher as banks try to ensure they won’t buckle under the Fed’s nightmare scenarios. While the exams are given to dozens of large banks, the central bank has already eased the burden for all but the biggest lenders. It has done so by letting them out of the so-called qualitative side of the tests, which the industry considered harder to manage than the more straightforward quantitative aspect of the tests.

The annual reviews required under the Dodd-Frank Act are set for further changes. Fed officials are planning to make the process more transparent, and Fed Vice Chairman for Supervision Randal Quarles has said the regulator is also working to eliminate at least one of the capital ratios it measures.

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