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Major US banks face 'stress tests'
Last Updated(Beijing Time):2009-02-26 07:40

The Obama administration hopes to restore confidence in the nation's ailing financial sector by subjecting 19 of the largest banks to "stress tests" that will gauge whether each institution has adequate capital to survive a severe downturn.


A view of the US Treasury Department. US authorities announced plans Wednesday for so-called stress tests to be conducted through April on the "capital adequacy" of troubled major commercial banks. [Agencies] 

Banks that need new funds will be given six months to obtain it from the private sector or, failing that, from the federal government's $700 billion bank rescue program, the US Treasury Department said Wednesday.

Government officials haven't specifically said which banks will be subject to the tests, but under the government's criteria they would include large nationwide banks such as Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. The 19 largest banks hold two-thirds of the banking industry's assets.

Treasury officials said the new support will be provided through the government's purchase of preferred shares of the banks' stock that are convertible into common shares at a 10 percent discount to their price before Feb. 9. The additional financing will be available immediately if needed, the department said.

The preferred shares will carry a 9 percent dividend and be convertible at the bank's option, subject to regulatory approval. They will automatically convert in 7 years. Banks seeking additional funds will have to demonstrate how they would use the money to support their lending activities. Those plans would be made public.

The option to convert the preferred shares into common shares is a change in the rescue program designed to give the government greater flexibility in managing its assistance. The conversions would give the government larger ownership stakes and dilute current shareholders. That has raised concerns the government could ultimately takeover, or nationalize, ailing banks.

The Treasury Department also provided details of how the new stress tests will function. The tests will be conducted by bank regulators, including the Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and Office of Thrift Supervision.

Government officials hope the tests will boost market confidence in the banks by making it clear the institutions either have the necessary capital to weather a major downturn, or will obtain it from private investors or the government.

Bank regulators said they wouldn't release the tests' results, but the banks will likely make some disclosure of the outcome, particularly if it shows they don't need more capital. Banks that seek private capital likely will indicate how much they need and the government will announce any new investments.

Daniel Alpert, managing director of Westwood Capital LLC, an investment bank, said the stress tests will "force reality to the surface" by demonstrating that many large banks face increasing losses on commercial real estate and other assets. Westwood holds a small stake in Citigroup.

Administration officials did not say whether they expect to request more taxpayer money to fund the next round of investments in banks, beyond general statements that they would provide the capital that banks need.

But in his speech to Congress Tuesday evening, President Barack Obama said more money beyond the $700 billion committed last year would be needed. Saying he understands bank bailouts are unpopular, he insisted it was the only way to get credit moving again to households and businesses.

Scott Talbott, a lobbyist for the Financial Services Roundtable, said the 9 percent dividend would be a "burdensome" cost for most banks. That means only those facing severe difficulties would likely seek new government funds.

That's a contrast from the original bank rescue program, which the Bush administration said was intended for healthy banks. More than 400 financial institutions received about $200 billion in taxpayer money under that program.

Meanwhile, Fed Chairman Ben Bernanke on Wednesday again spurned speculation that the government may nationalize Citigroup or other large financial institutions.

During an appearance before the House Financial Services Committee, Bernanke said nationalization "is when the government seizes the bank and zeros out the shareholders and begins to manage and run the bank. And we don't plan anything like that."

But the Fed chief said it is possible the government could end up with a much bigger ownership stake in Citigroup or other banks. In the case of Citigroup, Bernanke said "we'll see how their test works out and what evolves."

Citigroup has been involved in talks with regulators over ways the government could help strengthen the bank, including use of the stock conversion plan. New York-based Citigroup already has received $45 billion in bailout money, plus guarantees to cover losses on hundreds of billions of dollars in risky investments.

The new stress tests will use two economic scenarios to gauge banks' health and are expected to be completed by the end of April.

The "baseline" scenario envisions the nation's gross domestic product, which is the value of all goods and services produced within the US, falling 2 percent this year, unemployment rising to 8.4 percent and home prices dropping 14 percent.

The "adverse" scenario assumes GDP will drop 3.3 percent, unemployment rising to 8.9 percent and home prices falling 22 percent this year.

For all of 2008, GDP rose 1.3 percent, which was the smallest increase since 2001. In the fourth quarter, GDP fell 3.8 percent, the biggest contraction since 1982.

The unemployment rate last month surged to 7.6 percent, the highest in more than 16 years. It was 5.8 percent last year, the highest since 2003.

Median home prices in the US fell 9.5 percent last year, according to the National Association of Realtors, though many big cities like Los Angeles, Las Vegas and Miami showed far larger declines.

The stress tests will consider a typical regulatory measure of a bank's capital reserves, known as "Tier 1 capital," government officials said, but will emphasize tangible items such as shareholders' equity. Investors no longer trust Tier 1 capital, analysts have said, because it includes intangible assets such as operating losses that can be used to reduce future tax liabilities.

Source:Agencies 
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