March 12, 2015

The Federal Reserve failed by submitting banks to an incomplete stress test.

Sir I refer to Tom Braithwaite, Ben McLannahan and Barney Jopson’s report on the recent stress tests performed by the Federal Reserve ad that that have given the US banks a clean bill of health, “European banks fail US stress tests”, March 12.

It is the Federal Reserve who has really failed the test by only testing for the assets banks have on their balance sheet, and not for the assets that should have been there. In other words, one thing is for banks to have sufficient equity for what they are doing, and another quite different sufficient equity for what they should be doing, if complying with their societal purpose of efficient credit allocation.

Banks have been made dysfunctional by the introduction of distorting credit-risk weighted equity requirements which favors assets perceived as “safe” As a result of this, banks in America (and in Europe) are not giving “risky” SMEs and entrepreneurs a fair and sufficient access to bank credit. For the banks to become functional again all differences in equity requirements against assets need to be eliminated. And to make room for such a leveling, basically all banks must increase their equity.

Our young, in order to have jobs and a decent future, need banks to take risks on “risky” small businesses and entrepreneurs. How many of these borrowers will now not be able to get credit, only because of the dividends and the buy-backs of shares the Federal Reserve’s incomplete stress tests stimulate?