All banks expected to pass stress test; analysts not so sure

— -- The U.S. banking industry is strong enough to weather a deteriorating economy — that's the headline expected from the government when it reveals the results of its bank stress tests in the first week of May.

"We expect the stress test to demonstrate that the 19 banks are all well capitalized even under the stress test's worst-case scenario," says Scott Talbott, senior vice president at the Financial Services Roundtable, which represents the largest financial institutions.

However, a chorus of bank analysts and economists are questioning the rigor of the stress tests if the results are really so positive. After all, just six months ago, the entire financial system was brought to its knees from the stress of capital market losses and rising mortgage defaults.

"If they come out and say all the banks are fine, no one's going to believe the test," says Christopher Whalen, managing director at analysis firm Institutional Risk Analytics.

In February, Treasury Secretary Timothy Geithner announced the Financial Stability Plan and said it would conduct a battery of tests to gauge the soundness of the nation's 19 largest banks, including Citigroup and Wells Fargo. The tests would determine if the banks have sufficient capital and could withstand a worsening recession over the next two years.

Related Stories

10-month-old baby has been found: Officials

• May 6, 7:21 PM

Vehicle crashes into White House gate, killing 1

• May 5, 2:53 AM

Man kills wife, 3 kids in mass shooting: Police

• Apr 23, 12:35 PM

The Treasury and the Federal Reserve mapped out the worst-case scenario as an unemployment rate of over 10% and housing prices falling 22% in 2009. But they left some questions unanswered, especially if the scenario worsened.

The problem is, the stress test is based on "best guesses" of how bad the economy will get, says Michael Heller, president of Veribanc, a bank-rating firm. That means that the worst-case scenario may not be pessimistic enough.

"The Treasury in May will release the amount of cushion that each bank needs in a more severe economic scenario," says Andrew Williams, a Treasury spokesman. He says the goal of the test was to "increase lending by instilling confidence in banks even if the economy worsens."