U.S. banking regulators on Wednesday launched a stress test program to assess larger banks' ability cope with a deeper and longer-than-expected recession that sees the unemployment rate climbing above 10 percent next year.
The stress tests, mandatory for institutions with over $100 billion in assets, will be used partly to determine whether the banks need additional capital from a new U.S. Treasury program for government convertible preferred stock investments.
The new Treasury program will be placed alongside a previous program that has injected nearly $200 billion into banks since last October. Both will draw from remaining funds in the Treasury's $700 billion financial rescue fund.
The stress tests, to be conducted by end of April by the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision, will measure banks against two economic scenarios -- baseline and more adverse.
The baseline scenario reflects a consensus expectation among private forecasters and the more adverse scenario reflects a deeper and longer recession than in the baseline, the regulators said in a statement.
The baseline scenario assumes real gross domestic product will fall 2.0 percent in 2009 and rise 2.1 percent for 2010. The more adverse scenario assumes a 3.3 percent fall in GDP for 2009 and a rise of just 0.5 percent.
For the unemployment rate, the baseline assumes 8.4 percent for 2009 and 8.8 percent for 2010, with the more adverse scenario at 8.9 percent for 2009 and 10.3 percent for 2010.
For home prices, the baseline assumes a 14 percent drop this year, while the more adverse scenario assumes a 22 percent drop.
The new Treasury Capital Assistance Program for the first time will give the government shares in banks that can be converted to common equity if necessary to boost a bank's tangible equity capital levels.
These securities will carry a 9 percent dividend yield and automatically convert to common equity in seven years -- a feature aimed at encouraging banks to redeem the shares or replace government capital with private capital.
(Reporting by David Lawder, Editing by Chizu Nomiyama)