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Stress-Testing the Big Banks

We ran our own stress test to discover which banks might need more government aid.

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There has been a lot of speculation about the Treasury's stress test that banks with more than $100 billion of assets will be forced to go through over the next two months. With just a little guidance available, we decided to come up with our own stress test to see which banks may look short of capital and which ones are likely to pass the test without the need for back-stop government capital.

Our Test
With Tier 1 ratios at historic highs, we chose to focus on the tangible common equity/tangible asset ratio (TCE ratio) to determine the strength of the bank. Regulators have not given any guidance on what is an acceptable minimum TCE ratio for a bank, so we used a 3% minimum, which appears to be the minimum acceptable ratio in the market for now. Using our projected earnings numbers, the banks' loan books, and (for some) securities at risk for write-downs, we tried to assess how much stress 14 large banks could take over the next two years before seeking government aid.

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Jaime Peters does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.