Can a test help stabilize the financial sector? The Obama administration seems to think so. They have introduced a stress test for US banks.

This test should determine how much capital a bank needs to survive a further deterioration of the economic situation. Amongst others, an assessment will be made of the amount of losses banks would incur in a worst case scenario of increasing unemployment, decreasing property values and a shrinking economy.

The nineteen largest US banks will be submitted to this stress test, the results of which will be published by the end of the month.

All banks would pass
Already, criticism on the stress test is mounting. Experts report in the New York Times that presently all banks would pass the test. None of them is currently so short on capital that closure would be necessary.

Joshua Rosner, managing director of New York investment-research firm Graham Fisher, has similar criticism. According to him, the macroeconomic forecasts used in the test are much too optimistic. Other economists agree. Amongst them is Nouriel Roubini of the New York University. According to him the current economic situation is already worse than the worst case scenario drawn in the test for 2009.

Political tool
The Nobel Prize winning economist Paul Krugman points an accusing finger at the government, claiming that they purposefully eased the test to make all banks appear solvable, while a lot of them are not.

Critics claim that the Obama administration uses the stress test as a political tool. If banks pass the test, it will be easier to get permission from Congress to inject more money into them. However, members of Congress will want to see results first.

The reason Obama needs to win over Congress is obvious: the 700 billion Tarp bailout fund is about to dry up. Besides, the test might help win over the US citizens, who are increasingly unhappy about tax money being spent to keep large banks afloat.

‘Not too pessimistic’
Douglas Elliott of the Brookings Institution, a Washington based think tank, offers a different view on the matter. According to him, an overly pessimistic stress test could actually be worse. “Although we all crave certainty, it would be better to wait until we knew that this pessimistic case was likely before nationalizing more widely, given the serious social and financial costs of that extreme step.”

It is currently unclear how much information on the results of the stress test will be released. Will a general overview be provided, or more specific results for each bank? Economists hope for as much transparency as possible, to help make a good assessment on the value of the stress test.

Your opinion?
The question remains, however, whether the results provide a realistic view on the future, or whether the test is forged to be of political benefit to banks and the government. Disruptivebanking.com looks forward to hearing your opinion.

(Source: het financieele dagblad)