Bankers could start huffing and puffing after a few minutes on the treadmill once Tim Geithner cranks up the dial a few notches.
The recently minted Treasury Secretary announced the broad outlines of his plan earlier this month for stabilizing the financial sector, which includes what he called a “stress test” of the big banks. Already investors are worried about how their banks will fare under such a test, even though the details are still pretty murky.
According to one definition, the test would look at the bank’s loans, try to determine which of them are likely to default, and decide if the bank will have enough money left in its reserves under a worst-case scenario. According to another definition making the rounds, the financial stress test would be a kind of super-duper audit.
Others say the test would involve determining how much capital the bank would have left if it wrote off all its losses immediately. The stress test would also examine how much capital the bank would have in the next few years if all its expected losses over that period were taken into account. The bank’s tax position and credit might also be factored into the equation.
Of course, there are all kinds of variables to take into account, and it isn’t clear how far the Treasury and other regulators such as the Federal Deposit Insurance Corp., the Office of Thrift Supervision, the Office of the Comptroller of the Currency, and the Federal Reserve will go with their testing. A presentation last July by an FDIC executive on stress testing loans in the commercial real estate segment recommends that financial institutions should perform stress tests to quantify the impact of changing economic conditions on asset quality, earnings, and capital. But last July seems like the good old days now, at least since the financial meltdown accelerated last fall.
FDIC chair Sheila Bair told CBS that stress tests will be conducted this week on the 20 largest banks and will look at whether the banks have an adequate buffer to survive in even harsher economic conditions than they have already encountered. The test would indicate if the banks will need more capital and if they would be able to raise it privately, or would need the government to step in with more help.
Investors are worried about the banks being nationalized, but Federal Reserve Chairman Ben Bernanke sounded a hopeful note Tuesday when he told Congress the recession may even come to an end this year, if government actions succeed. He also discounted the need to nationalize any banks. Bernanke talked about the financial stress tests as well, and indicated that banks undergoing the tests won’t be allowed to hide the bad assets lurking on their balance sheets. Whether a financial stress test will prove much better than a crystal ball is anybody's guess, but let's hope Bernanke’s cautious prediction about the end of the recession proves to be accurate.
