WHAT’S IN THE NEWS!!

Fed: Banks could lose $490 billion in next crisis CNN Money America's biggest banks would lose $490 billion -- most of that due to bad loans -- over the next nine quarters in a worst-case scenario devised by the Federal Reserve. Thankfully, the Fed does not expect that scary scenario to happen. But in an effort to prevent a repeat of the 2008 financial crisis, the Fed is putting the big banks through stress tests.

WHAT IS A STRESS TEST? A stress test, in financial terms, is an analysis or simulation to determine the ability of a financial institution to deal with an economic crisis. It is based on an examination of the balance sheet of that institution.economic crisis Beginning in 2007 governments around the world started conducting their own stress tests. In 2012 in the US regulators from different governing bodies in the US are now requiring them for even the small community banks as part of the Dodd-Frank Law (FINREG) in Another example of government regulation at work! We will more at this law (regulation)

QUESTIONS ASKED IN A STRESS TEST What happens if unemployement rises to xx% in a specific year? What happens if equity markets crash by more than x% this year? What happens if GDP falls by z% in a given year? What happens if interest rates go up by at least y%? What happens if oil prices rise by 200%?

News Article (cont) In the Fed's most adverse case, which calls for an unemployment rate reaching 10%, home prices falling 25% and stock prices plunging 60%, the average tier 1 common capital ratio for these banks (one of the Fed's metrics of bank health) would be 8.2% -- significantly above the 5.5% level that they had in early 2009.

News Article (cont) " The largest U.S.-based bank holding companies continue to build their capital levels and to strengthen their ability to lend to households and businesses during a period marked by severe recession and financial market volatility," the Fed said in a statement. Unsurprisingly, the lion's share of the loan losses would likely fall to the nation's four largest consumer banks: Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM) and Wells Fargo (WFC).BACCJPMWFC But all 31 banks did well on the stress test, which calls for banks to have a minimum capital ratio of 5% in the event that the bottom completely fell out of the job, housing and stock markets.

News Article (cont) Next hurdle: This is the first of two rounds of stress tests. Next week, the Fed will indicate whether or not it approves of plans by the big banks to raise dividends and buy back stock. That's the part of the test that Wall Street will be watching intently. Keep an eye on Citigroup. Citi failed this second test last year and was not allowed to raise its dividend as a result. Citi pays a dividend of just 4 cents a year.

DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT 2010 A US regulation that the Obama administration passed in 2010 in an attempt to prevent the events that caused the 2008 financial crisis from happening again. The Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as simply "Dodd-Frank", is supposed to lower risk in the U.S. financial system. It is named after U.S. Senator Christopher J. Dodd and U.S. Representative Barney Frank because of their involvement in the passage of the law.

DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT 2010 New government agencies were created to monitor banks that are considered “TOO BIG TO FAIL”. An agency can break up large banks that may pose a risk to the financial system because of their size. Another agency prevents lending to people who are not qualified or are getting loans they shouldn’t get. Even another rule restricts the way financial institutions can use derivatives and other such “shadow banking” instruments. We will learn more about shadow banking.