The Supervisory Capital Assessment Program, publicly described as the bank stress tests (even though a number of the companies that were subject to them were not banks), was an assessment of

capital Capital and its variations may refer to: Common uses * Capital city, a municipality of primary status ** Capital region, a metropolitan region containing the capital ** List of national capitals * Capital letter, an upper-case letter Econom ...

conducted by the

Federal Reserve System The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of ...

and thrift supervisors to determine if the largest U.S. financial organizations had sufficient capital buffers to withstand the

recession In economics, a recession is a business cycle contraction that occurs when there is a period of broad decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be tr ...

and the financial market turmoil. The test used two

macroeconomic Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as output/ GDP ...

scenarios, one based on baseline conditions and the other with more pessimistic expectations, to plot a ' What If?' exploration into the banking situation in the rest of 2009 and into 2010.The Supervisory Capital Assessment Program: Design and Implementation

Board of Governors of the Federal Reserve System The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is charged with overseeing the Federal Reserve Banks and with helping implement the m ...

. Published April 24, 2009. The capital levels at 19 institutions were assessed based on their Tier 1 common capital, although it was originally thought that regulators would use

tangible common equity Tangible common equity (TCE), the subset of shareholders' equity that is not preferred equity and not intangible assets, is an uncommonly used measure of a company's financial strength. It indicates how much ownership equity owners of common stoc ...

as the yardstick.Bank Stress Tests
Wikinvest The results of the tests were released on May 7, 2009, at 5pm EST. Before the tests were completed, the central problems facing the Treasury Department were (1) whether the tests would increase or decrease confidence in any companies that did badly on their tests and (2) whether or not the $350 billion in bailout funds that remained could cover the needed funding after the tests.What Does A Bank "Stress Test" Entail?
By Wyatt Andrews.

CBS News CBS News is the news division of the American television and radio broadcaster CBS. It is headquartered in New York City. CBS News television programs include ''CBS Evening News'', ''CBS Mornings'', news magazine programs ''CBS News Sunday Morn ...

. Published Feb. 25, 2009.

Scope and purpose

The exercise was limited to bank holding companies (national banks and companies which own banks) with assets greater than $100 billion. The 19 banking organizations included in the exercise comprised the core of the US banking system, representing roughly two-thirds of aggregate U.S.

bank holding company A bank holding company is a company that controls one or more banks, but does not necessarily engage in banking itself. The compound bancorp (''banc''/''bank'' + '' corp ration') or bancorporation is often used to refer to such companies as w ...

assets.Bank Stress Test FAQ
''

The Wall Street Journal ''The Wall Street Journal'' (''WSJ''), also referred to simply as the ''Journal,'' is an American newspaper based in New York City. The newspaper provides extensive coverage of news, especially business and finance. It operates on a subscriptio ...

''. Published Feb. 25, 2009. The supervisors conducted the capital assessments on an interagency basis to ensure that they were carried out in a timely and consistent manner. Each participating financial institution was instructed to analyze potential firm-wide losses, including in its loan and securities portfolios, as well as from any off-balance sheet commitments and contingent liabilities/exposures, under two defined economic scenarios over a two-year

time horizon A time horizon, also known as a planning horizon, is a fixed point of time in the future at which point certain processes will be evaluated or assumed to end. It is necessary in an accounting, finance or risk management regime to assign such a f ...

(2009 – 2010). In addition, firms with trading assets of $50 billion or more were asked to estimate potential trading-related losses under the same scenarios. Participating financial institutions also forecasted internal resources available to absorb losses, including pre-provision

net revenue In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, and ...

and the allowance for loan losses. As part of the supervisory process, the supervisors met with

senior management Senior management, executive management, or upper management is an occupation at the highest level of management of an organization, performed by individuals who have the day-to-day tasks of managing the organization, sometimes a company or a cor ...

at each financial institution to review and discuss the institution's loss and revenue forecasts. Based on those discussions, the supervisors assessed institution-specific potential losses and estimated resources to absorb those losses under the baseline and more adverse case, and determined whether the institution had a sufficient capital buffer necessary to ensure it had the amount and quality of capital necessary to perform its vital role in the economy.

Macroeconomic scenarios and assumptions

The capital assessment covered two economic scenarios: a baseline scenario and a more adverse scenario.

Baseline scenario

For implementation of the supervisory capital assessment program, the baseline assumptions for real

GDP growth Gross domestic product (GDP) is a monetary measure of the total market value of all the final goods and services produced and rendered in a specific time period by a country or countries. GDP is often used to measure the economic performanc ...

and the

unemployment rate Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is the proportion of people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work d ...

for 2009 and 2010 were assumed to be equal to the average of the projections published by Consensus Forecasts, the

Blue Chip Economic Indicators Blue Chip Economic Indicators is a monthly survey and associated publication by Wolters Kluwer collecting macroeconomic forecasts related to the economy of the United States. The survey polls America's top business economists, collecting their fo ...

survey, and the

Survey of Professional Forecasters The Survey of Professional Forecasters (SPF) is a quarterly survey of macroeconomic forecasts for the economy of the United States issued by the Federal Reserve Bank of Philadelphia. It is the oldest such survey in the United States. The survey ...

in February 2009. This baseline was intended to represent a consensus view about the depth and duration of the recession. Given the current uncertain environment, there is a risk that the economy could turn out to be appreciably weaker than expected in the baseline outlook. The assumptions for the baseline economic outlook are consistent with the house price path implied by futures prices for the Case-Shiller 10-City Composite index and the average response to a special question on house prices in the latest Blue Chip survey.

More adverse scenario

To aid financial institutions in their ongoing

risk management Risk management is the identification, evaluation, and prioritization of risks, followed by the minimization, monitoring, and control of the impact or probability of those risks occurring. Risks can come from various sources (i.e, Threat (sec ...

practices, the supervisors have also put together an alternative “more adverse” scenario. By design, the path of the US economy in this alternative more adverse scenario reflects a deeper and longer recession than in the baseline. The consensus expectation is that economic activity is likely to be better than shown in the more adverse alternative; nonetheless, an outcome such as the alternative cannot be ruled out. The “more adverse” scenario was constructed from the historical track record of private forecasters as well as their current assessments of uncertainty. In particular, based on the

historical accuracy Historicity is the historical actuality of persons and events, meaning the quality of being part of history instead of being a historical myth, legend, or fiction. The historicity of a claim about the past is its factual status. Historicity denot ...

of Blue Chip forecasts made since the late 1970s, the likelihood that the average unemployment rate in 2010 could be at least as high as in the alternative more adverse scenario is roughly 10 percent. In addition, the

subjective probability Bayesian probability ( or ) is an interpretation of the concept of probability, in which, instead of frequency or propensity of some phenomenon, probability is interpreted as reasonable expectation representing a state of knowledge or as quanti ...

assessments provided by participants in the January Consensus Forecasts survey and the February Survey of Professional Forecasters imply a roughly 15 percent chance that

real GDP Real gross domestic product (real GDP) is a macroeconomic measure of the value of economic output adjusted for price changes (i.e. inflation or deflation). This adjustment transforms the money-value measure, nominal GDP, into an index for quantit ...

growth could be as least as low, and unemployment at least as high, as assumed in the more adverse scenario. For the more adverse scenario, house prices are assumed to be about 10 percent lower at the end of 2010 relative to their level in the baseline scenario. Based on the year-to-year variability in house prices since 1900, and controlling for macroeconomic factors, there is roughly a 10 percent probability that house prices will be 10 percent lower than in the baseline by 2010.

Scenario macroeconomic variables

Results and consequences

The capital assessment is intended to capture all aspects of a financial institution's business that would be impacted under the baseline and more adverse scenarios. Supervisors will carefully evaluate the forecasts submitted by each financial institution to ensure they are appropriate, consistent with the firm's underlying portfolio performance and reflective of each entity's particular business activities and risk profile. The assessment of the firm's capital and the size of any potential needed additions to capital will be determined by the supervisors. The assessment of

capital adequacy A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ...

considers many factors including: the inherent risks of the institution's exposures and business activities, the quality of its

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

assets and its

off-balance-sheet In accounting, "off-balance-sheet" (OBS), or incognito leverage, usually describes an asset, debt, or financing activity not on the company's balance sheet. Total return swaps are an example of an off-balance-sheet item. Some companies may have ...

commitments, the firm's earning projections, expectations regarding economic conditions and the composition and quality of its capital. Specific factors supervisors consider include: uncertainty about the potential impact on earnings and capital from current and prospective economic conditions; asset quality and concentrations of credit exposures; the potential for unanticipated losses and declines in asset values; off-balance sheet and

contingent liabilities In accounting, contingent liabilities are liabilities that may be incurred by an entity depending on the outcome of an uncertain future event such as the outcome of a pending lawsuit. These liabilities are not recorded in a company's accounts ...

(e.g., implicit and explicit liquidity and credit commitments); the composition, level and quality of capital; the ability of the institution to raise additional

common stock Common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or ordinary shares in the UK and other C ...

and other forms of capital in the market; and other risks that are not fully captured in regulatory capital calculations. Under current rules for

bank holding companies A bank holding company is a Holding company, company that controls one or more banks, but does not necessarily engage in banking itself. The Compound (linguistics), compound bancorp (''banc''/''bank'' + ''corporation, corp

ration Rationing is the controlled distribution (marketing), distribution of scarcity, scarce resources, goods, services, or an artificial restriction of demand. Rationing controls the size of the ration, which is one's allowed portion of the resourc ...

') or banco ...

, supervisors expect bank holding companies to hold capital above minimum regulatory capital levels, commensurate with the level and nature of the risks to which they are exposed. That amount of capital held in excess of minimum capital requirements should be commensurate with their firm-specific risk profiles, and account for all material risks. The assessment of capital under the two macroeconomic scenarios being used in the capital assessment program will permit supervisors to ascertain whether the buffer over the regulatory capital minimum is appropriate under more severe but plausible scenarios. An institution that requires additional capital will enter into a commitment to issue a CAP convertible preferred security to the

U.S. Treasury The Department of the Treasury (USDT) is the Treasury, national treasury and finance department of the federal government of the United States. It is one of 15 current United States federal executive departments, U.S. government departments. ...

in an amount sufficient to meet the capital requirement determined through the supervisory assessment. Each institution will be permitted up to six months to raise private capital in public markets to meet this requirement and would be able to cancel the capital commitment without penalty. The CAP convertible preferred securities will be converted into common equity shares on an as-needed basis. Financial institutions that issued preferred capital under Treasury's existing

Capital Purchase Program The Capital Purchase Program or CPP is an American government preferred stock and equity warrant purchase program conducted by the US Treasury Office of Financial Stability as part of Troubled Asset Relief Program (aka, TARP) that was launched in 2 ...

(TARP 1) will have the option of redeeming those securities and replacing them with the new CAP convertible preferred securities. The capital assessment is part of the supervisory process and thus subject to the same framework used for bank examinations or bank holding company inspections. There will be ample opportunity for discussions between the financial institutions and supervisory agencies regarding the loss estimates and earnings forecasts during the capital assessment process.

Banks tested

The nineteen bank holding companies being stress-tested are as follows: The capital needs found by the test are based on the adverse scenario for the recession. All of these bank holding companies currently exceed the legally mandated capital requirements. However, the government will try by extra-legal means to compel those who are found to need more to obtain it.

Endnotes

External links

Lessons from the Crisis Stress Tests (March 26, 2010)WSJ: Results fudgedFAQs
Released 7 May 2009.

{{USGovernment, article=Supervisory Capital Assessment Program, url=http://www.fdic.gov/news/news/press/2009/pr09025a.pdf Stress tests (financial) Federal Deposit Insurance Corporation Financial regulation in the United States 2009 in economic history Great Recession in the United States