The Federal Reserve released details on its stress tests, or how it will assess the strength and resilience of bank holding companies in an adverse economic and financial market environment.
Results of the stress tests are expected on Thursday.
In November, the Federal Reserve issued its final rule requiring all U.S.-based, top-tier bank holding companies with assets of at least $50 billion to develop and submit capital plans to the central bank on an annual basis. The rule applies to 30 holding companies.
The holding companies are examined under hypothetical scenarios developed to determine their flexibility in a deep recession that begins in the fourth quarter of 2011. In the scenarios, the unemployment rate increases by an amount similar to that experienced in severe recessions over the past 40 years, accompanied by a notable decline in global economic activity.
Under the hypothetical trajectories, gross domestic product contracts sharply through late 2012, with the unemployment rate reaching a peak of just above 13% in mid-2013. U.S. equity prices fall by 50% from their third quarter 2011 values through late 2012 and home prices fall by more than 20% through the end of 2013.
The scenario also assumes severe asset price declines on domestic and global financial assets.
The Federal Reserve’s analysis of each holding company’s capital plan focus on four areas: The comprehensiveness of the capital plan; the reasonableness of the bank holding company’s assumptions and analysis; the company’s capital policy governing distributions and other capital actions; and its ability to maintain capital above specified minimum regulatory capital ratios.
The Federal Reserve will notify each bank holding company of whether the Fed objects to the institution’s capital plan. Holding companies are required to update and re-submit their capital plans within 30 days if the central bank objects to the plan. If the Fed objects to a capital plan, a bank holding company cannot make capital distributions unless the Fed specifically indicates it does not object to the distribution.
The stress tests build on tests conducted in 2011 to ensure that institutions have capital planning processes that account for unique risks and ensure that institutions have sufficient capital to survive economic and financial stress.