The Federal Deposit Insurance Corporation (FDIC) recently issued proposed regulations that require nearly two dozen banks to conduct stress tests that measure capital levels under varying economic and financial scenarios. These new regulations cover nearly two dozen mid-size and lesser known banks regulated by the FDIC.

SEE: Who Backs Up The FDIC

Stress Tests
The FDIC is charged under Section 165 of the Dodd-Frank Act to ensure that state nonmember banks and state chartered savings associations run annual stress tests. These tests would assess the impact of different financial and economic scenarios on an institutions earnings and capital strength. These proposed regulations cover 23 institutions with greater than $10 billion in consolidated assets.

The banks will conduct the stress tests under three different scenarios, including a baseline, adverse and severely adverse. The tests will estimate the pro forma impact of these scenarios on capital and earnings every quarter utilizing a nine quarter forward time horizon.

The results will contain estimated losses by exposure category, pre-provision net revenue, changes in loan loss reserves, total assets, aggregate loan balances and anticipated capital distributions over the time horizon. The 23 institutions would also be required to publish a summary of the results of the stress tests for investors and shareholders to examine.

Some of the publicly traded institutions covered by these proposed regulations include New York Community Bancorp (NYSE:NYB), BancorpSouth (NYSE:BXS), Umpqua Holdings (Nasdaq:UMPQ), First Republic Bank (NYSE:FRC) and Synovus Financial (NYSE:SNV), according to the Wall Street Journal. (For related reading, see Banking Stress Tests: Would Yours Pass?)

Buyer Beware
Although these tests seem fairly comprehensive, the FDIC stressed that the tests only measure the capital adequacy of an institution under a range of scenarios over a fixed time horizon, and should be viewed as only one measure of the financial strength of a bank. The stress tests do not measure a bank's liquidity, the impact of interest rates changes or the capital planning process.

Another problem with the tests is the lag time before investors can examine the results of the stress tests. The banks will conduct the tests based on data for the period ending September 30 of each year and must report the data to the FDIC the following January. The banks then must release the results to the public within 90 days. This timing process might mean that investors may receive data that is seven months old.

The usefulness of the tests might also vary by institution as the proposed regulations only state that a bank has to release a "summary" of the results, leaving the amount of disclosure at the discretion of each bank.

The Bottom Line
The government is not finished with implementing the increased regulation required under the Dodd-Frank Act, and has proposed stress tests for mid-size banks under its jurisdiction. Although these tests are not a 100% reliable predictor of future problems, any step towards more disclosure is welcome and should make investors happy. (For more, read The History Of The FDIC.)

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