Banks May Need New Stress Tests, Panel Says

By Amit R. Paley
Washington Post Staff Writer
Tuesday, June 9, 2009

The federal government should repeat its stress tests of the nation's largest banks if its assumptions about the severity of the economic downturn prove too rosy, according to a congressional oversight report to be released today.

The Congressional Oversight Panel, which oversees the $700 billion government bailout of the financial industry, generally praised the bank evaluations, which assessed the firms' financial health, and lauded regulators for using a reasonable model to conduct the tests.

But the panel, headed by Harvard Law School professor Elizabeth Warren, noted that the stress tests assumed an average unemployment rate of 8.9 percent this year under the worst-case scenario. The unemployment rate for last month, however, climbed to 9.4 percent, meaning the assumptions by regulators might have been too optimistic.

Federal Reserve Chairman Ben S. Bernanke, whose agency conducted the stress tests, has previously defended the rigor of those evaluations against criticism from economists and other skeptics, who questioned the underlying assumptions.

While the oversight panel praised the Fed for releasing an unprecedented amount of information about banks, the report criticized the regulators who performed the tests for not releasing enough information about how the evaluations were conducted, saying the lack of transparency raised "serious concerns" and left "unanswered questions."

"Without this information, it is not possible for anyone to replicate the tests to determine how robust they are or to vary the assumptions to see whether different projections might yield very different results," the report says. "It may fail to capture substantial risks further out on the horizon."

Stress tests of the nation's largest 19 banks, released last month, concluded that 10 of them needed to raise a combined $75 billion in common equity to withstand an even more severe financial crisis. That figure was much lower than many analysts had expected, buoying confidence in the banking industry.

The 154-page report called for the banks to be subject to further stress tests as long as they continue to hold large amounts of toxic assets on their books. The panel also said that regulators should retain the power to conduct stress tests even beyond that time, and that banks should be required to run internal evaluations between federal tests and share the results with regulators.

While the panel painted the stress tests as a useful exercise, the report urged that they should be used cautiously.

"While no one should gainsay the potentially positive results of the tests," the report said, "it would be equally unwise to think that those results reflect a diagnosis of all of the potential weaknesses or create a necessarily sufficient buffer against future reverses for the banking system."

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