Yesterday, the Federal Reserve announced the results of its latest round of stress tests on American banks, Bloomberg reports. The stress tests, which were authorized by the Dodd-Frank Act, seek to simulate what would happen to banks’ balance sheets in times of economic hardship. Put into place after the financial crisis several years ago, the tests seek to prevent a repeat of bank failures by providing for worst case scenarios before they occur.
This time, though, the Federal Reserve’s results may be harsher than those obtained by banks themselves. Banks had conducted an independent series of stress tests this past September, which showed that the banking industry was healthy as a whole and that the sector had recovered somewhat from the disasters of 5 years ago. The Fed’s methods, however, incorporate historical and industry-wide data into their analyses, much more so than individual banks, which tend to conduct their tests on a more case-by-case basis.
A big difference between the two approaches is that the Fed anticipates assets rising in times of economic distress, which simulates historical trends. Most banks tend to consider that assets will decrease in value during recessions, an approach that the Fed has claimed is completely unjustified by past experiences.