Most large banks appear to have been sailing through the annual “health checkups” that they have had to undergo since the financial crisis began, but on Monday, the Federal Reserve described some significant shortcomings in banks’ responses to the so-called stress tests, The New York Times DealBook reported yesterday. Despite the severity of the recent housing crisis, the Fed said that some banks were not taking into account the possibility of falling home prices when valuing certain mortgage-related assets for the tests. In other cases, banks assumed they would be strong enough to take business away from competitors in times of stress. In its review released on Monday, the Fed appeared most concerned that banks were applying the tests too generally. Under the tests, the banks have to assume weakness in the economy and turmoil in the markets, and then calculate the losses they would suffer under such conditions. The banks then subtract those losses from capital, the financial buffer they maintain to absorb losses. If the assumed losses cause capital to fall below a regulatory threshold, the banks effectively fail the test.
