US announces start of 'stress tests' for major banks


Posted at Feb 26 2009 10:10 AM | Updated as of Feb 26 2009 06:10 PM

WASHINGTON - US authorities launched a new phase of their bank rescue plan 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 program announced by the administration of President Barack Obama, which according to some analysts could lead to big government stakes and possibly nationalization.

But Elsa Dargent of the investment firm Natixis said that "this program puts off the eventuality of a large-scale nationalization of US banking institutions."

Banks with assets of at least $100 billion 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.

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 Program, 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 nationalize key banks that need shoring up. US officials have taken pains to say the program aims to keep the banking system in private shareholder hands.

Separately, Federal Reserve chairman Ben Bernanke told lawmakers the government was not seeking to take control of banks.

Bernanke said that he opposed "zeroing out stockholders and then putting the government in charge of running the institution I don't think we want to do that. And I don't think we need to do that."

"But I think we have the tools, short of those Draconian measures, to make sure the banks return to viability and to extending credit to the public," he added.

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, officials said.

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

Officials said the program 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.

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.

John Ryding, economist at RDQ Economics, said it was not clear if the scenario was pessimistic enough.

Ryding also said he was perplexed by the decision to convert preferred shares to common stock, saying this was simply "moving cash from one bucket to another."

The administration still must find a way to help banks cleanse their books of toxic assets resulting from the meltdown in the real estate market.

As a result, he said the latest plan is "necessary but it's clearly not sufficient" to rescue the sector.