Federal Reserve reveals new stress tests for nation’s largest banks

A new test will require the largest banks to prove stability if a counterparty fails.

Large U.S. banks are preparing for more regulation, courtesy of the federal government. This time, though, the governmental actions have nothing to do with preventing another mortgage crisis. Instead, the Federal Reserve wants to know: If another global recession occurs, are large banks prepared to weather the economic crisis?

On Nov. 1, the Federal Reserve released the latest round of “stress tests,” designed to determine whether the banks can handle several hypothetical scenarios put forth by the government. While these tests have been in place since the 2010 passing of the Dodd–Frank Wall Street Reform and Consumer Protection Act, and have been conducted since 2012, the Federal Reserve added one new test for the largest banks this year over concerns they are becoming too reliant on counterparties.

In the new test, eight large banks must show that they would be able to withstand the collapse of a counterparty, such as another bank or large money-market mutual fund, with capital of its own. According to The Wall Street Journal, the purpose of these tests is to make sure that all banks are conservatively capitalized and should force banks to take a closer look at short-term deals such as repurchase agreements.

"The counterparty default stress test is an indication that the Fed is still very focused on the risk of short-term liquidity problems," attorney Paul L. Lee told the WSJ.

Banks must submit their plans to the Federal Reserve by Jan. 6, 2014. The Fed will then decide whether to accept or reject the bank’s plan and reward shareholders based on the results of the stress tests.

Large banks aren’t the only ones conducting the stress tests this year, however. As InsideCounsel examined in the October issue of our monthly print magazine, mid-size banks are subjected to Federal Reserve testing for the first time this year as well. All banks between $10 billion and $50 billion in total consolidated assets will need to prove their viability in the event of an economic collapse as well.

 

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