Bank Stress Test Results Are Just Window Dressing

  • window dressing: an adroit but superficial or actually misleading presentation of something, designed to create a favorable impression.
    the government’s effort has amounted to little more than window dressing” (Oxford Languages)

BANK STRESS TESTS – FEELING GOOD AND TALKIN’ THE TALK

The Federal Reserve recently reported the results of its annual economic stress tests for banks. The test supposedly indicates how banks can be expected “to perform under certain hypothetical economic conditions.”

The reason it is termed a stress test is because the hypothetical conditions are negative in nature…

The 2024 stress test shows that the 31 large banks subject to the test this year have sufficient capital to absorb nearly $685 billion in losses and continue lending to households and busi- nesses under stressful conditions.Executive Summary @ federalreserve.gov

The June 26, 2024 press release stated that the “Federal Reserve Board annual bank stress test showed that while large banks would endure greater losses than last year’s test, they are well positioned to weather a severe recession and stay above minimum capital requirements“.

This year’s test was modified to be more stringent in order to reflect the possibility of more severe liquidity problems for banks in light of numerous bank failures experienced last year, highlighted by Silicon Valley Bank (SVB). Below is how the matter was addressed by Fed Chair Jerome Powell at that time…

So, I guess our view is that the banking system is sound and it’s resilient—it’s got strong capital [and] liquidity. We took powerful actions with [the] Treasury and the FDIC, which demonstrate that all depositors’ savings are safe and that the banking system is safe.Mar 22, 2023 

The statement was a bit premature as other banks subsequently failed. Anxiety was calmed however, and fears were tempered. A followup statement by Chair Powell provided additional reassurance…

“The U.S. banking system is sound and resilient, with strong levels of capital and liquidity. (Powell, July 23, 2023)

QUESTIONS AND CONCERNS 

What if conditions are worse than those simulated in the stress tests? In financial and economic matters, it most always seems to be that way. The current stress test parameters allow for declining interest rates. The Fed may want to see rates lowered in a crisis, but wholesale dumping of worthless credit obligations would send interest rates through the roof. We saw that in 2008 with residential mortgages specifically and bonds in general. The Fed might not be able to stem the tide with purchases for their own account as they did then.

Banks are notoriously illiquid. There are no reserve requirements. The 10% fractional-reserve requirement based on total bank deposits was eliminated several years ago. That’s not much, but, at least it provided a measure of (il)liquidity and a margin of solvency. For example, if a bank has $1MM in deposits and lends out $900,000, the remaining $100,000 is still available to meet withdrawal demands. Now that the reserve requirement has been eliminated, it is not unrealistic to assume that some (or, most) banks probably have loaned out more money than they have in total deposits. In other words, there are no reserves, so how can a bank be expected to meet net outflows/withdrawal demand?

The reserve requirement was eliminated for two reasons: 1) to support efforts to flood the economy with money in response to the forced Covid shutdown and resumption of economic activity afterwards and 2) most banks were probably in danger of violating the existing 10% reserve requirement; remove the requirement and the problem goes away – for a little while, maybe. (see more about fractional-reserve banking)

The banks aren’t satisfied, though. They want less stringent requirements.

CONCLUSION

The extent and duration of pending financial and economic crises will be worse than any previous ones. The events themselves and their negative effects will confirm that bank stress tests and their results are inadequate, unreliable, and virtually worthless.

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!

Fractional-Reserve Banking Is The Elephant In The Room

(Note: This article is an updated version of an original article published in 2017.  On March 15, 2020, the Federal Reserve Board reduced reserve requirement ratios to zero percent effective March 26, 2020.  The action eliminated reserve requirements for all depository institutions.)

FRACTIONAL-RESERVE BANKING

The expression “elephant in the room“…

“…an important or enormous topic, question, or controversial issue that is obvious or that everyone knows about but no one mentions or wants to discuss because it makes at least some of them uncomfortable or is personally, socially, or politically embarrassing, controversial, inflammatory, or dangerous. (source

A wordy definition, yes; but it is applicable to our topic of Fractional-Reserve Banking. After reading the rest of this article, you should be able to see just how important and enormous  Fractional-Reserve Banking is; as well as how dangerous.

Lets’s start with some history.

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