December 02, 2016

That banks have strengthened is pure wishful thinking, as most of it is the result of weakening the real economy.

Sir, Brooke Masters’ writes: “Eight years after the financial crisis, we were all getting bored with bank stress tests. Most of the institutions are so much stronger and better capitalised than they were” “UK’s tough stance on banks contrasts with global mood” December 3

That’s not really so. Most of the strengthening is the result of banks shedding “risky” assets in favor of safe, so the other side to that coins is having in the medium and long term run made the real economy weaker.

As I have complained about for years, current stress tests only look at what is on the balance sheets of banks, ignoring completely the aspect of what should have been there.

With respect to “imposing “output floors” on the models. These would effectively raise capital requirements for some banks by pushing up the value of their risk-weighted assets”, the real question is, how could regulators be so naïve so as to think those risk models were not going to be tweaked? Lower risk determination, means lower capital requirements, means higher leverages, means higher expected risk adjusted returns on equity.

With respect to “floors unfairly penalise banks with unusually safe assets, such as those who keep a lot of low-risk mortgages on their books”, the question is when will banks keep on favoring the “safer” construction of basements were the jobless young can live with their parents over the “riskier” lending that could allow the young to find the jobs they need in order to become responsible parents too?

Sir, you want strong banks? Keep them on a tight capital leash without distorting what they do? You want weak banks? Make them operate only in what is safe and help them with their returns on equity by being very accommodative allowing high leverages.