"Stress-Testing" the Banks ? Not Very Stressful

Since 2008, on both sides of the Atlantic, so-called stress-tests have been and are being conducted by financial regulators to establish their capital adequacy. So far as I am concerned, anything that intelligently bolsters the limited, formulaic 'day-to-day' CapAd assessments made by the banks themselves is worth entertaining: we know that pre-crisis bank capitalisation was culpably inadequate.

Except that what is being done should never be dignified with the name of Stress Test. All the talk is of modest 'haircuts' to represent the downside of potential sovereign default: but as we wrote in 2007 when bank default was the issue of the day, nothing short of testing for outright default is sufficient.

Here is what the Bank of International Settlements - essentially the highest authority on the subject - says in its 2009 guidelines on the matter, written with the benefit of very recent Crisis hindsight and insight:

"Stress tests should feature a range of severities, including events capable of generating the most damage whether through size of loss or through loss of reputation. A stress testing programme should also determine what scenarios could challenge the viability of the bank"
(Principle 9, my emphasis)

Authorities please note: call a spade a spade, but don't call a haircut a Stress Test.

ND