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New global shock test scenarios

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The Federal Reserve's annual stress tests has become a high-drama news event, one that has vexed and embarrassed companies like Bank of America and Citigroup in previous years.

Since the tests began in 2009, there have been times when both banks were optimistic about getting the green light to deliver capital back to shareholders, only to have those expectations shattered, leaving management humiliated. Banks have since learned to play the game a bit better. Only a foolish bank will allow itself to get too ambitious in requests to return capital.

Hopefully, this year's tests will not dash any ambitions. Banks would be wise to keep expectations in check and their requests modest. The Fed will announce test results at 4:30 PM on March 7. Information about banks' capital plans, the Comprehensive Capital Analysis and Review, will be released at 4:30 PM on March 14.

Bloomberg reports that the Fed has released the economic shock scenarios that will be used to gauge the strength of the banks.

"The scenarios released today contain data on global equity markets in dozens of countries and how much they might decline from an adverse shock. Banks must test, for example, against a 33 percent drop in equities in China, a 60 percent decline in Spain, and a 75 percent decline in Ireland. The central bank previously released the economic scenarios in November. The worst of those parameters would test the bank against a recession in which U.S. gross domestic product declines by 6.1 percent and the unemployment rate climbs as high as 12.1 percent."

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