Market watchers patiently waiting for the results of bank stress testing will have to wait for another 10 days before they have all the answers they’re looking for, but a just released report shed some light on how the tests are being conducted. Many were hoping that the report would release the names of financial institutions being tested and details on how they fared, but they were instead given general information about the stress testing.

The overriding message in the 21 page report is that most financial institutions are well capitalized, but that capital levels have suffered greatly as a result of losses associated with bad loans and toxic assets on bank balance sheets. No big surprises there.

The stress test involves two different scenarios. The first is based on how the bank would perform if the economy behaved in line with consensus opinions from a group of economists that have issued forecasts. The second scenario is based on what would happen to the bank if unemployment hit double digits and home values fell by another 20% in the next two years. Regulators are trying to get an idea of how the banks will fare under expected conditions as well as under more financial pressure.

The hope is that the results of the stress test will reveal which banks are best positioned to survive in either scenario, and which banks are most likely to struggle. The government can then use this information to determine how to best use the funds set aside to help banks until they’re able to recover on their own.

Critics of the stress testing are concerned for a couple of reasons. First, the economy has worsened since the factors for the stress tests were decided in February, so we’re essentially using data that is a couple of months old to grade banks that could be doing substantially better or worse in reality. Home values and unemployment have both gotten worse since the stress testing was announced.

Another concern is that these results are coming too late in the game. Reports indicate that of the $700 billion set aside for bank bailouts, just under $600 billion has already been allocated. Even with stress test results, the government is getting to the point where their influence will be limited unless they approve the use of even more taxpayer dollars for the TARP program, an unlikely scenario.

May 4^th is the new day to circle on your calendar to watch for more specific test results. Government officials will spend the time between now and then meeting with executives from these banks, so we could see some banks proactively making adjustments prior to the announcement of the test results.

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Tags: Bailout, banks, Stress Test

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