Most large banks appear to have been sailing through the annual “health checkups” they have had to undergo since the financial crisis.
But on Monday, the Federal Reserve described some significant shortcomings in the banks’ responses to the so-called stress tests.
Despite the severity of the recent housing bust, the Fed said some banks weren’t taking into account the possibility of falling house prices when valuing certain mortgage-related assets.
In other cases, banks assumed they would be strong enough to take business away from competitors in stressed times.
In its review released Monday, the Fed appeared most concerned that banks were applying the tests too generally. In other words, such banks didn’t pay enough attention to the risks that were particular to their assets and operations. Banks excluded material that was relevant to the bank’s “idiosyncratic vulnerabilities,” the Fed said.
Under the tests, the banks have to assume weakness in the economy and turmoil in the markets, and then calculate the losses they would suffer under such conditions. The banks then subtract those losses from capital, the financial buffer they maintain to absorb losses. If the assumed losses cause capital to fall below a regulatory threshold, the banks effectively fail the test.The New York Times