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. Cost Test

    A standard test applied to a process to determine if the net ...
  2. Total Revenue Test

    A test that approximates the price elasticity of demand by comparing ...
  3. Acceptance Testing

    A functional trial performed on a product before it is put on ...
  4. Aptitude Test

    An exam used to determine an individual's propensity to succeed ...
  5. Bonferroni Test

    A type of multiple comparison test used in statistical analysis. ...
  6. Support Test

    One of five tests that must be passed in order to claim someone ...
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. Insights

    Fed's Tarullo Talks Amid Simmering Bank Revolt (MS)

    Big banks may be considering legal action against the Fed over new stress-test rules regarded as onerous by the industry
  4. 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.
  5. 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.
  6. Investing

    6 Bank Stocks Fueled by Share Buybacks

    Following the Fed's stress tests, analysts expect banks to increase share buybacks and dividend payouts.
  7. Investing

    Why Are Banks Hold Nearly $2.5 Trillion in Bonds?

    Banks are holding the biggest dollar amount of bonds since the central bank began compiling data in 1973
  8. Personal Finance

    10 Stressful Jobs With Low Pay

    If you're doing one of these jobs, it's probably for reasons other than the pay, whether it's helping people, your country or your community.
  9. Personal Finance

    8 Careers That Pay Less Than You Think

    If you ever thought EMTs or reporters make a lot of money, you'd be wrong.
  10. Investing

    Berkshire To Be Largest Bank of America Shareholder

    Warren Buffett's Berkshire Hathaway will hold more than $17 billion worth of Bank of America stock.
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. Can your insurance company drug test you?

    Learn why drug companies conduct drug tests and how a lifestyle free of drugs and alcohol can save you big money on health ... Read Answer >>
  4. What factors are the primary drivers of banks' share prices?

    Find out which factors are most important when determining the share price of banks and other lending institutions in the ... Read Answer >>
  5. What is usability testing, and why is it so important in the Internet sector

    Learn why a company would want to conduct a usability test and what types of data and information become available with this ... Read Answer >>
  6. 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 >>
Hot Definitions
  1. Leveraged Buyout - LBO

    The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. ...
  2. Current Assets

    A balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within ...
  3. Tax Liability

    The total amount of tax that an entity is legally obligated to pay to an authority as the result of the occurrence of a taxable ...
  4. Preferred Stock

    A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
  5. Net Profit Margin

    Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
  6. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
Trading Center