Fed Stress Tests Add Risk to the Financial System

On March 14, after the markets closed, the 29 banks that hold about three-quarters of US banking assets waited to hear if they passed or failed the Federal Reserve’s annual stress tests. The results seemed reassuring. The Fed gave a passing grade to 14 and a failing grade to two, required two others to address some additional weakness by later this year, and didn’t disclose its conclusions about the 11 smaller institutions.

Stress-testing got us out of the financial crisis in May 2009, and it has since become the crisismanagement tool of choice in the banking industry. But how well is it serving the country?

One unquestionably positive result is that banks have built up the capabilities to see how they would fare through different crisis scenarios. They must consider a mind-bending array of outcomes and have enough capital to deal with them – from what might happen to checking accounts and mortgages, to all those loans to develop shopping malls, to the derivatives that grease the global financial system. Bank regulators now can develop their own views of those questions and, more important, of the answers given by the banks.

Fed Stress Tests Add Risk to the Financial System