Big banks face a major test this week, when the Federal Reserve carries out the second and more consequential part of its annual stress tests.
The results from the first part of the exam, released last week, reflected well on the health of the financial system. In a hypothetical financial crisis scenario, all 31 banks examined would maintain adequate capital levels to survive, the Fed found.
But this week is the real test, with the Fed set to fail banks if they don't measure up. The exercise, begun in 2009 to shore up confidence in the soundness of the banking system, can carry serious consequences for banks. If they fail, regulators can stop them from paying out dividends to shareholders or buying back shares, and big bank executives' jobs could hang in the balance.
Whereas Thursday's tests analyzed how banks' balance sheets would hold up if unemployment skyrocketed, stocks and housing prices collapsed, and corporate bond defaults rose, the results to be released Wednesday will involve bank-specific analysis. In particular, the Fed will look at each bank's plans for raising capital or distributing cash to shareholders, and at qualitative factors that add to the banks' risk.