Fed To Force 6 U.S. Banks to Undergo 'Global Market Shock' Stress Test

The Federal Reserve announced late Tuesday that it plans to force the six largest U.S. banks to undergo a new round of rigorous stress tests. According to the Federal Reserve, the new round of tests would assume a hypothetical market shock, including a significant deterioration in the European debt crisis.

The Fed said Tuesday that the so-called “global market shock test” for the top six banks are to generally mirror the price and rate movements seen in the U.S. in the second half of 2008, and also on "potential sharp market price movements in European sovereign and financial sectors."

In the this new hypothetical stress test scenario, the banks are to assume that the unemployment rate would spike to as high as 13% while U.S. economy (as measured by gross domestic product) would fall by as much as 8%.

The Fed said it will publish next year the results of the tests for six banks that have large trading operations which include: Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Morgan Stanley (MS) and Wells Fargo (WFC).

The implementation of the new stress tests would seem to confirm the fact that the Federal Reserve is worried about the impact of the European Debt crisis on banks here in the U.S. Recall that up until now, U.S. officials have waved off concerns that the European crisis could have a negative effect on U.S. banks. U.S. Treasury Secretary Timothy Geithner is on record as saying the impact on our banks is extremely modest.

The new test will be on top of the larger supervisory tests that the Fed will conduct on U.S. banks and holding companies with total consolidated assets of $50 billion or more. Reuters reports that these tests will be applied to 31 firms, 19 of which have already been through the stress test process and 12 new firms.

The banking institutions will be expected to have credible plans that show they have sufficient capital so that they can continue to lend even under adverse conditions, and are well prepared to meet regulatory capital standards agreed to by the Basel Committee on Banking Supervision as they are implemented in the United States.

According to reports, the banks must submit their plans for any capital increased to the Federal Reserve by January 9, 2012, with a response expected from the Fed by March 15.

Reuters is reporting that the Fed will use the stress tests to determine whether banks are robust enough to raise dividends or repurchase stock, or whether they need to obtain additional capital.

The Fed says it plans to release more information than it did during the last round of stress tests results. According to Reuters, a Fed regulator said it is doing so to "foster market discipline."

Recall that Fitch Ratings noted concern earlier in the month about how well U.S. banks would hold up to the sovereign debt crisis occurring in Europe. According to reports, Fitch said their concerns were based on the size of U.S. banks’ trading operations in Europe.

The Fitch report, dated November 16 said, "Our concern is with counterparty risk, the impact of Europe on global economic growth and how that weighs on the economic recovery in the U.S."

Stock markets around the globe suffered declines in response to the news of the enhanced stress tests on U.S. banks.

 

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