Fed takes stress test: u.s. Banks are more resilient to crisis

Fed takes stress test: U.S. banks are more resilient to crisis

Only the cash reserves of car and home financier ally financial slipped below the required threshold in the assumed crisis scenario.

Banks have improved their resilience to extreme economic scenarios, the fed said thursday in washington. They are better capitalized than they were before the financial crisis that led to the collapse of the lehman brothers investment bank in september 2008 and to distress sales of other financial firms.

In the annual stress test, the fed calculates what would happen to the reserves of financial firms if markets and the real economy suddenly collapsed. The fed wants to make sure that even in extreme cases, banks have enough money to meet their obligations. During the financial crisis, the government had to step in.

Over the past four years, capital quality and quantity have improved significantly, said fed director daniel tarullo. As a result, the institutions were "better able to provide money to consumers and companies, even in difficult economic times". In last year’s stress test, 4 of 19 banks had still flunked, including citigroup.

The fed built a real scare into its stress test: stock prices plummeted by more than half, housing prices melted by a good 20 percent, and the unemployment rate peaked at 12.1 percent. By way of comparison, unemployment in the U.S. Currently stands at 7.9 percent; the peak during the recession was 9.9 percent. The total loss, which would have to put away the banks under the test conditions within nine months, put the fed at 462 billion dollar (355 billion euro).

But the stress test is no mere theory; it has very practical implications: based on the results, the fed determines the maximum amount of capital reserves that individual institutions are allowed to tap in order to pay dividends or buy back shares. However, this data will not be published until thursday of next week.

However, critics question the methodology of the stress test. Ally financial, the only candidate to fail this year, called the stress test "fundamentally flawed". The results would contradict historical experience. Ally financial used to be called GMAC and was the financial subsidiary of the car company general motors. In the financial crisis, the company had to be rescued by the state, which still holds a majority stake.

The stress test is part of the dodd-frank act – the package of laws meant to rein in wall street after the financial crisis. Europe’s banks are likely to face another such stress test this year. The outcome of this is likely to be more exciting than in the U.S., where the number of bad home loans in particular has declined, given the ongoing debt crisis. That relieves the balance sheet of the banks.

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