Banks would make losses in the second year and scant profits in the first and third years of a stress test exercise undertaken by APRA and published yesterday in its occasional title Insight.APRA worked with 20 banks to model a "severe but plausible" scenario originating in a macro-economic shock modelled to have begun in the 2009/10 financial year.The Reserve Bank of New Zealand worked with the Australian Prudential Regulation Authority on the tests.Paul Tattersall, head of the industry analysis team at APRA, described the scenario as "a continued deterioration of global economic conditions. "World growth and industrial output were assumed to be weaker than consensus expectations as at June 2009, particularly in China, and there was an ongoing drag from weakened North Atlantic banks. "This global scenario generated an economic downturn in Australia significantly worse than that experienced in the early 1990s."Tattersall wrote that the global deterioration was the result of a decline in the responsiveness of rich-world consumers to policy stimulus; North Atlantic banks being unable to complete equity raisings, and deep cuts in business investment and employment as the private sector responded to lower levels of spending."The faster rate of labour-shedding feeds into weaker consumption and greater losses in relevant banking systems," he wrote."Funding premiums widen, so that cost of funding above the cash rate increases by 100 basis points over the existing spread as at mid-2009."The model assumes that China is not able to offset all of the decline in its exports with domestic spending. As a result, the rate of growth of the Chinese economy falls by at least as much as other countries. Commodity prices fall by 60 per cent."This stress scenario was, by design, demanding," Tattersall wrote.The model used unemployment peaking at 10.8 per cent, a house price decline of 12 per cent for two years in a row and a recession in commercial property.None of the 20 Authorised Deposit-taking Institutions would have failed under the downturn macro-economic scenario, APRA found.Nor would the ADIs have breached the four per cent minimum tier-one capital requirement of the Basel II framework.APRA said the weighted average reduction in tier-one capital ratios from the beginning to the end of the three-year stress period was 3.1 percentage points.Banks would make losses in the second year of the three-year scenario, with an average negative return on assets across the banks of minus 0.2 per cent.Profits constituting an ROA of only plus 0.2 per cent in the first year and 0.1 per cent in the  third year are hardly likely to generate dividends.