What is a 'Bank Stress Test'

A bank stress test is an analysis conducted under unfavorable economic scenarios designed to determine whether a bank has enough capital to withstand the impact of adverse developments. Banks with $50 billion in assets are required to do internal stress tests by their own risk management team and also stress tests from the Federal Reserve.

BREAKING DOWN 'Bank Stress Test'

Stress tests focus on a few key risks, such as credit risk, market risk and liquidity risk, to banks' financial health in crisis situations. Hypothetical crises are determined using various factors from the Federal Reserve and International Monetary Fund (IMF). Bank stress tests were put in place and became more widespread after the 2007-2009 global financial crisis, the worst since the Great Depression. This crisis left many banks and financial institutions severely undercapitalized, which the stress tests aim to prevent.

Two Types of Stress Tests

The Federal Reserve conducts annual supervisory stress tests of banks with $50 billion or more in assets. The main goal of this stress test is to see whether a bank has the capital to manage itself during tough times.

Company-run stress tests are done on a semi-annual basis and fall under strict reporting deadlines. The results of these company-run tests have to be reported to the Federal Reserve by Jan. 5 and July 5.

Both stress tests come with a common set of scenarios for banks to evaluate. An example is the hypothetical situation of a 10% unemployment rate, 5% drop in stocks and 30% plunge in home prices. Banks then use the next nine quarters of projected financials to determine if they have enough capital to make it through the crisis.

Impact of Stress Tests

Banks that go through stress tests are required to publish their results. These results are then released to the public to show how the bank would handle a major crisis. New regulations require companies that do not pass stress tests to cut their dividend payouts and share buybacks to preserve capital.

Sometimes banks are given a conditional basis passing of a stress test. This means a bank came close to failing the stress test and risks being able to make further distributions in the future. Banks that pass on a conditional basis have to resubmit a plan of action. Banks that fail the stress tests look bad to the public based on the threat of a financial disaster. Foreign banks such as Santander and Deutsche Bank have failed stress tests multiple times.

RELATED TERMS
  1. Supervisory Capital Assessment ...

    A financial stress test conducted by the Federal Reserve System ...
  2. Macroprudential Analysis

    A method of economic analysis that evaluates the health, soundness ...
  3. Capital Requirement

    The standardized requirements in place for banks and other depository ...
  4. European Banking Authority (EBA)

    The European Banking Authority (EBA) is a regulatory body that ...
  5. Liquidity Risk

    The risk stemming from the lack of marketability of an investment ...
  6. National Bank

    In the United States, a commercial bank chartered by the comptroller ...
Related Articles
  1. Managing Wealth

    An Investor's Guide To Bank Stress-Testing

    Just how are bank stress tests performed and what is the logic behind them? And is a stress test useful for evaluating a bank's stock?
  2. Investing

    EU Bank Stress Test Results: A Preview

    The tests of 51 banks covering 70% of total banking assets across the EU come at a time of great turmoil in banking when many financial shares have plunged
  3. Investing

    Banking Stress Tests: Would Yours Pass?

    In weaker economic times, banks may be tested by the government to see how safe they are.
  4. Investing

    Banks Survive Economic Shock in Fed Stress Test

    America's most systemically important banks proved able to withstand a severe economic shock according to the Fed's annual stress test.
  5. Managing Wealth

    4 Ways Companies Can Relieve Workplace Stress

    Workplace stress can cost companies tons of money in lost productivity and absenteeism. Some of that is out of their control, but often they are the cause.
  6. Financial Advisor

    Stressed Out? How Advisors Can Deal with It

    Financial advisors face loads of stress, especially during troubled times. Here's how to deal with the job's stresses and gain a competitive edge.
  7. Managing Wealth

    Jobs With Great Pay, But Huge Stress

    You may want these jobs for the pay and the benefits, but the work can be a killer.
  8. Financial Advisor

    Why Asset Managers Oppose Mutual Fund Stress Tests

    The Financial Stability Board wants to implement a financial stress test for mutual funds for the G20 nations. Here's why it is an unpopular idea.
  9. Personal Finance

    The Least Stressful Jobs In The U.S.

    As the U.S. unemployment market begins to experience growth, this article looks at the growing demand for low-stress jobs.
RELATED FAQS
  1. How stressful is the typical corporate finance job?

    Learn more about careers in corporate finance, the stress associated with those jobs and why investment bankers feel the ... Read Answer >>
  2. What average annual growth rate is typical for the banking sector?

    Learn the typical average annual growth rate for the banking sector and why regulatory requirements have a profound effect ... Read Answer >>
  3. How does analyzing a bank's financial statements differ from companies in other sectors?

    Learn why analyzing banks' financial statements is very different from nonfinancial service companies. Review relevant examples ... Read Answer >>
  4. What is the long-term outlook of the banking sector?

    Find out about the long-term outlook for the banking sector. It has significantly changed after legislation that passed in ... Read Answer >>
  5. How are bank reserve requirements determined and how does this affect shareholders?

    Learn how bank reserve requirements are determined and how bank reserves affect shareholders through improved bank stability ... Read Answer >>
  6. What do banks do to control the bank reserve?

    Understand what the Federal Reserve does in order to expand or contract the economy. Learn what depository institutions can ... Read Answer >>
Hot Definitions
  1. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
Trading Center