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Stress Tests

relates to Stress Tests

Daniel Acker/Bloomberg

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Doctors make patients jog on a treadmill to see if their hearts can withstand stress. Regulators do the same to banks, minus the treadmill. Financial stress tests run lenders through a simulated workout to separate banks that can stay on their feet in a crash from those that can’t: What if interest rates shoot up? What if China’s economy tanks? What if unemployment surges and homes lose a fifth of their value? What if all those things happen at the same time? Vigorous health checks for lenders became a pillar of banking supervision in the wake of the 2008 financial crisis. Some were more successful than others at restoring credibility to the system.

After a decade of tougher supervision, stress tests are becoming a more routine affair. They give regulators a way to push banks to build higher loss buffers, limit cash payouts and improve monitoring of risk. In the U.S. Federal Reserve's 2018 exercise, only one bank failed – Deutsche Bank’s U.S. unit – though six banks were forced to scale back proposals for returning cash to shareholders. In the 2017 test, every lender passed for the first time. In Europe, results of the next stress test are due by the end of 2018, though regulators stopped delivering pass/fail grades with their last exam in 2016. In that one, Italian lenders were again in the spotlight, as they were in 2014 when 25 out of 130 banks failed in the largest-ever exercise, which aimed to restore confidence and end a two-year slump in lending that had choked off Europe’s economic recovery. The last European test was criticized for its limited scope.