US announces start of ‘stress tests’ for major banks

Published by rudy Date posted on February 27, 2009

WASHINGTON: US authorities launched a new phase of their bank rescue plan on Wednesday including a requirement for so-called stress tests on the “capital adequacy” of troubled major commercial banks.

The tests are a key element of the bank rescue programme announced by the administration of President Barack Obama, which according to some analysts could lead to big government stakes and possibly nationalisation.

Banking regulators said the tests were “to determine if the largest US banking organisations have sufficient capital buffers to withstand the impact of an economic environment that is more challenging than is currently anticipated.”

Banks with assets of at least 100 billion dollars will be subject to the tests, which will be used to determine the need for new capital injections or other government aid under the rescue plan for struggling financial firms, according to a statement from regulators.

Examiners “will assess institution-specific potential losses and estimated resources to absorb those losses under the baseline and more adverse case, and determine whether the institution has a sufficient capital buffer necessary to ensure each institution has the amount and quality of capital necessary to perform their vital role in the economy.”

The stress tests are a key part of the Obama administration’s plan to help rescue banks hammered by losses from the US real estate meltdown and subsequent credit crunch.

Under the Capital Assistance Programme, the government may inject new capital in the form of preferred shares that pay a nine percent dividend and can be converted to common stock.

The plan “is designed to give banks the incentive to replace (government) provided capital with private capital or to redeem the (government) capital when conditions permit,” a Treasury statement said.

Officials said the 19 largest bank holding companies would be subject to the tests.

“The federal supervisory agencies will conclude their work as soon as possible, but no later than the end of April,” said a joint statement from the Federal Reserve, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency and Office of Thrift Supervision.

Some analysts have argued that by converting the preferred shares to common stock, the government would gain large stakes and effectively nationalise key banks that need shoring up. US officials have taken pains to say the programme aims to keep the banking system in private shareholder hands.

If a bank is determined to be in need of new capital, it will be given up to six months to raise private capital and return the investment from the government without penalty.

The convertible preferred securities “will be converted into common equity shares on an as-needed basis,” the statement said.

The six-month window is “important in terms of private market function,” a senior government official, who requested anonymity, told reporters.

The supervisors’ assessments of the banks will be kept confidential, as is customary with other bank supervisions, officials said.

But banks will be required to submit a plan for the use of funds when they apply to the programme and the plan will be made public.

Officials said the programme aimed to boost confidence in the financial system where confidence has all but vanished in an accelerating global financial crisis that has brought the world economy to a virtual standstill.

Asked how confidence would be improved if the results of assessments remain confidential, an official acknowledged: “It’s hard to know,” saying the hope was that “our lending will be creating some certainty … that banks have access to common equity over time.”

Officials said it was too early to put a dollar amount on the programme ahead of the assessments. “We’re committed to this programme,” an official said.

Recipients of capital will be subject to the executive compensation limits announced earlier this year by the Obama administration. They will also be limited to dividends of one cent per share per quarter.

Limits also could be imposed on repurchasing shares, and pursuing cash acquisitions.

The stress tests would examine the potential losses for banks under an “adverse” scenario that is weaker than the consensus economic forecasts. These adverse scenarios include unemployment surging as high as 10.3 percent in 2010 and home prices falling another 22 percent in 2009. – AFP/de

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