Stress Testing Banks

(Mostly Window Dressing)

The much ballyhooed stress tests to be given to systemically important banks are mostly window dressing, but could still have serious consequences by giving the regulators an occasion to do whatever they want to do.

I call them window dressing because stress tests using various assumptions, including dire assumptions, have long been a routine bank practice insisted on by the regulators. Moreover, regulators routinely embed themselves inside major banks on an ongoing basis. They pretty much know all there is to know about the condition of the banks they supervise and regulate, including the quality of and the results from the stress tests. If the condition of a major bank deteriorates, the number of examiners present is increased.

Given the routine stress testing already done routinely, the announcement of uniform stress tests has very little meaning, except to buy some time and give the regulators a public "occasion" to take action if they choose to do so. The word "uniform" in a uniform stress test could also turn into something of plausible significance, but only if the regulators wish it so. It is doubtful they will, however, since another term for systemically significant banks is too big to fail.

Making much of new, uniform, stress testing could backfire on the regulators by triggering calls for "transparency" in a practice that has previously been confidential, and for good reason. Opening up a bank's books to the uninitiated could be problematic since everyone knows, in theory, that no bank-even the soundest of banks-can withstand a run.