Stress tests for banks: The Fed ignores reality

In order to gauge the strength of the U.S. banking system, the Federal ReserveThe central bank in control of regulating the U.S. financial and monetary system. (Fed) required banks to complete their third stress test since 2009. Developed after the financial crisisAn economic downturn resulting from the failure of banking and government agencies to regulate and adjust to developing market conditions. as a spindly string attached to the Big Bank bailouts, stress tests are now an annual exercise for the nation’s biggest lenders.

Taking preventative action, stress tests aim to locate banking institutions’ weak areas at an early stage. As part of the stress test, banks are subjected to unfavorable hypothetical economic scenarios and must manipulate their capital ratio to maintain liquidity and meet specific reserve requirements above regulatory minimums. Stress tests focus on fundamental financial perils, such as credit, market and liquidity risks, to assess banks’ financial health and determine whether they have enough capital to endure the impact of an economic crisis.

Notably, stress tests do not review the status of assets to deposits test.

Of the 19 largest U.S. banks tested, 15 were able to manipulate their capital ratios, which compare high-quality capital to risk-weighted assets, above four separate regulatory minimum levels. Still, the Fed criticized how some of these banks calculated potential losses and dividend payments.