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Posts Tagged ‘Bank Stress Test methodology’

Bank Stress Tests? Take Home Exams and Partially Self-Graded

Posted by Larry Doyle on April 24th, 2009 3:10 PM |

The Treasury just released the methodology used in assessing the vitality of the 19 largest banks via the Bank Stress Tests. The market took the release of this methodology as a big yawn. Treasury offered that the capital at some banks has been “substantially reduced.”  Please tell us something we don’t know.

The worst case scenario used by Treasury still falls into the camp of what most analysts view as the expected scenario.

In reading deeper into some of the reviews of the methodology, I am struck by the leeway provided to the banks in measuring the credit quality of loans on the banks’ books and the likelihood of deterioration on those loans. I view that as the wiggle room described by Meredith Whitney earlier this week.

As Bloomberg reports, Fed Says Capital at Some Major Banks Is Substantially Reduced:

“Firms were allowed to diverge from the indicative loss rates where they could provide evidence that their estimated loss rates were appropriate,” the study said.

Regulators used the market shocks of the second half of 2008, when Lehman Brothers Holdings Inc. declared bankruptcy, as the model for testing banks with trading portfolios of $100 billion or more.

As they pored over banks’ loan and securities portfolios and off-balance-sheet liabilities, examiners increasingly focused on the quality of credits. They were concerned about wide variations in underwriting standards, a regulatory official said this week.

Supervisors concluded that banks’ lending practices need to be given as much weight as macroeconomic scenarios in determining the health of each bank, the official said.

The goal of the reviews is to keep the major financial institutions lending over the next two years, and to determine how much capital they may need if the economic slump worsens.

Supervisors will weigh how much capital each company holds, its ability to retain earnings over the next few years, future access to private capital and the extent any asset writedowns.

The Bank Stress Tests are not only largely a take home exam, but now we discover they are partially self-graded.

Call me suspicious.

In speaking with friends on Wall Street, I have heard from a number of individuals that there is still a large short base in a number of the financials. The short base is providing a strong cushion to that sector specifically and the market in general.


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