The Fed Will Release Bank Stress Test Results Soon. Here's What to Watch

If you invest in large or regional U.S. bank stocks, you are going to want to pay attention to this year's stress test results. As part of the sweeping Dodd-Frank Act legislation for banks following the Great Recession, the Federal Reserve puts bank holding companies through various economic scenarios each year to determine whether banks can maintain adequate capital if a severe recession were to occur. The goal of this is to make sure banks can continue to provide credit to individual borrowers and businesses during a downturn. The tests also influence a bank's capital distribution plans including share repurchases and dividends because the Federal Reserve wants to also ensure that a bank's capital distributions do not push bank capital levels below certain regulatory thresholds in an adverse scenario.

There are two types of stress tests: the Dodd-Frank Act Stress Test (DFAST) and the Comprehensive Capital Analysis and Review (CCAR). Both are similar in nature and complement one another, but in DFAST the Fed applies a standardized capital distribution plan into its calculations. In CCAR, a bank's actual capital distribution plan such as its expected dividends are incorporated into the calculations of regulatory ratios in a given scenario. That means banks can pass DFAST only to find their actual plans resulted in the bank falling below regulatory minimums in CCAR, suggesting their capital distributions plans may have been too ambitious. This year, 34 large banks with more than $100 billion in total assets will undergo both DFAST and CCAR. The results of both tests will be released on June 25. Here is what to keep an eye on:

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Source Fool.com