Not Another Stress Test!

Paranormal Activity 2, Harry Potter Deathly Hallows part 2, and even Tony Parker’s number 2… Does everything come in twos nowadays? After launching quantitative easing 2 a few weeks ago, the U.S. Fed is now keeping markets abuzz with its latest pursuit – U.S. Banks Stress Tests 2.

Yep, you heard right! In a move to step up bank regulation in the middle of all the global financial hoopla, the Fed announced its plans to pore over the economy’s 19 largest bank-holding companies for the second time since early 2009.

This time around, the Fed isn’t doing it to address a pressing problem. Think of it as prevention rather than cure. The Fed is requiring the top 19 banks to submit capital plans by January 7 next year to establish that they can weather “adverse economic conditions” over the next two years, including the new banking regulations and the country’s mortgage-related problems.

If you can dig deep enough into your memory bank and recall the pre-Justin Bieber days in early 2009, you’ll remember that U.S. regulators stress-tested the very same 19 companies.

The tests’ results revealed that banks faced almost $600 billion in losses, which was addressed by padding up capital reserves. No doubt the transparency of the tests greatly helped restore confidence in the battered U.S. banking industry last year.

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Yet what sets this round of stress tests apart from the one we saw in 2009 is the fact that the results won’t be available to the public.

Adding to that, banks will also be required to design their own metrics to measure their capabilities. The Fed is particularly interested in finding out their ability survive extreme financial events.

Last but not the least, the Fed will be asking each company how it plans to meet Basel III requirements, which is something new. As you may know, the Basel III accord, which I wrote about in a previous blog post, was only finalized a couple months ago and sets new guidelines regarding capital requirements.

If you ask me though, it won’t be as difficult this time around since many banks have already taken the initiative to test themselves and avoid too much risk. In fact, big credit card companies, such as American Express and J.P. Morgan Chase & Co., have already started to cut back on lending.

Now for the question you’ve all been waiting for: Will the upcoming stress tests be bullish or bearish for the dollar?

It seems bullish because it will show that the government is determined to prevent a second financial meltdown from happening. While the results won’t be published, the stress tests will be a way to assure the market that banks have the necessary capital available to withstand losses.

But the Fed’s plan doesn’t come without a criticism. Apparently, smaller banks are complaining that stress tests run contrary to the Fed’s plan. The stricter capital requirements will make it more difficult for them to provide credit to businesses who need them, which would slow down the pace of economic recovery.

Better to be safe than sorry, I always say. Now is the time for the U.S. financial sector to restore confidence of the American people and avoid taking any unnecessary risks. It’s time for them to show that they are worthy and capable of handling the money of the American people.