Stress Tests: From stressful times to business as usual

May 2008
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FS viewpoints: Stress Tests: From stressful times to business as usual

At a glance

The Treasury Financial Stability Plan will subject banks to a "comprehensive stress test", allowing regulatory agencies to assess banks' ability to support lending and capacity to absorb losses under a severe economic outlook. This document provides our point of view and a framework for response.

The banking agencies have lifted much of the uncertainty clouding banks over the past year. The results have instilled greater confidence that banks would be able to continue their lending activities while weathering a severe economic recession, and the associated disclosures have addressed concerns for increased transparency in the banking industry by consistently applying criteria across firms. This document summarizes PwC perspectives on the stress testing results, including the implications of these changes going forward. Key messages include:

  • Stress tests - at least temporarily - create higher capital targets for the largest US banks; open questions remain on how stress tests will impact the evolution of the regulatory capital framework
  • Stress tests introduce new explicit targets focused on composition / quality of capital
  • The immediate focus for all banks is to develop capital plans to raise common equity and/or support the repayment of TARP funds
  • Bank executives will begin to focus on assessing business model implications and the impact on returns on capital across asset classes and activities
  • Comprehensive stress tests will be integrated into "business as usual" processes for management and supervisors going forward
  • Finally, as an outcome of the stress tests, risk management oversight will be reinforced and further disclosures expected