The U.S. Federal Reserve Board is stepping up stress testing for the biggest banks in the United States, a move that will also put the U.S. operations of some of Canada's largest financial institutions under the microscope.
Amid growing economic woes in Europe, officials in Washington unveiled plans Tuesday to subject all U.S. banks with more than $50-billion (U.S.) in assets to annual tests of their financial strength, including the ability to withstand another recession.
A total of 31 financial institutions will be subject to the annual tests, including 19 that participated in a round of tests earlier this year to determine their exposure to financial turmoil in the United States and Europe. The Fed also plans to make some of the results public.
The U.S. operations of Royal Bank of Canada and Bank of Montreal are both on the list and will be subject to stress tests. RBC operates a large wholesale and investment bank out of New York, while BMO has an extensive network of branches throughout the U.S. Midwest.
The stress tests are part of U.S. financial regulatory reforms.
However, Toronto-Dominion Bank, which has the largest U.S. network of any Canadian bank with 1,300 branches, is not on the list, because it is covered by older legislation and therefore exempted until 2015.
TD must still meet U.S. capital adequacy guidelines. A spokesman for TD said the bank conducts internal stress tests on its operations as a matter of course.
The list of U.S. banks subject to the annual process includes Bank of America Corp., Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley, and Wells Fargo & Co.
The shifting economic landscape in Europe, with Italy facing a debt crisis that could spread to other countries, has forced regulators around the world to more closely scrutinize their banking systems.
Stress tests are used to bolster confidence in the banking system in difficult times, and help to indicate which banks need to build a larger capital buffer to stabilize their operations.
But their impact has been mixed. Stress tests done in the United States three years ago helped to calm jitters over an economic slowdown when several banks were able to show they were well capitalized even in a downturn.
However, stress tests have come under fire over the past few years, since an attempt to determine the strength of European banks last year deemed that many were healthy. Several, including some of France's largest banks, have since been hit by concerns over sovereign debt crises in Italy and Greece.
In particular, the Fed said it wants to test the ability of big banks to shoulder "a sizable shortfall in U.S. economic activity and employment, accompanied by a notable decline in global economic activity."
The tests will involve a hypothetical scenario of a recession beginning late this year, along with a rise in unemployment to more than 13 per cent next year. Banks must submit financial data to the U.S. regulator by early February.
The move to scheduled annual stress tests in the United States differs from the situation in Canada, where similar procedures to test bank stability are undertaken periodically.
It is likely, however, that Canadian regulators will take a close look at Canadian banks in the months ahead, given the uncertainty in Europe, to ensure that they would not be hit hard by a recession.
A spokesman for Canada's Office of the Superintendent of Financial Institutions said the regulator conducts periodic stress tests on Canadian banks and updates them amid times of economic upheaval.
Canada's banking regulator does not keep a set schedule for stress tests, deciding to conduct them "as needed" and does not make the results public.