WASHINGTON - The Obama Administration hopes to restore confidence in the nation's ailing financial sector by subjecting 19 of the largest banks to "stress tests" that will gauge whether each institution has adequate capital to survive a severe downturn.
Banks that need new funds will be given six months to obtain it from the private sector or, failing that, from the federal government's $700 billion bank rescue program, the U.S. Treasury Department said yesterday.
Treasury officials said the new support will be provided through the government's purchase of preferred shares of the bank stock that are convertible into common shares at a 10 percent discount to their price before Feb. 9.
The preferred shares will carry a 9 percent dividend and be convertible at each bank's option, but subject to regulatory approval.
The option to convert the preferred shares into common shares is a change in the rescue program designed to give the government greater flexibility in managing its assistance. Common shares absorb losses before preferred shares do, which means that under a stock-conversion plan, taxpayers would be on the hook if banks keep writing down billions of dollars' worth of rotten assets, such as dodgy mortgages, as many analysts expect they will.
However, common stock in banks is incredibly cheap, and taxpayers would reap gains if the banks come back to health and the stock price rises.
The Treasury Department also provided details of how a new stress test will function to ensure banks have enough capital to survive a downturn that would be even more severe than the current recession. The tests will be conducted by bank regulators, includ-ing the Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, and Office of Thrift Supervision.
Government officials hope the tests will boost market confidence in the banks by making it clear the institutions either have the necessary capital to weather a major downturn, or will obtain it from private investors or the government.
The results will help regulators decide whether banks may need additional assistance so they can carry out the critical mission of boosting lending to customers, a key ingredient to the economic turnaround.
Bank regulators said they wouldn't release the tests' results, but the banks will likely make some disclosure of the outcome, particularly if it shows they do not need more capital. Banks that seek private capital probably will indicate how much they need, and the government will announce any new investments.
Yesterday Fed Chairman Ben Bernanke spurned speculation the government may nationalize Citigroup Inc. or other large financial institutions.
Appearing before the House Financial Services Committee, Mr. Bernanke said nationalization "is when the government seizes the bank and zeros out the shareholders and begins to manage and run the bank. And we don't plan anything like that."
But the Fed chief said it is possible that the government could end up with a much bigger ownership stake in Citigroup or other banks than it now holds.
The new stress tests will use two economic scenarios to gauge banks' health and are expected to be completed by the end of April.