Tags: Fed | stress | tests | banks

Former Fed Official: Banks Simply Trying to Please Fed in Stress Tests

Wednesday, 20 Mar 2013 12:54 PM

By Dan Weil

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When it comes to bank stress tests, the institutions are unfortunately seeking to give the Federal Reserve what it wants, rather than truly examining all their risk issues, says Til Schuermann, a former senior vice president at the New York Fed.

“As the Fed's models have become more and more important in deciding the fate of the biggest banks, those banks have focused more and more on trying to mimic the Fed's results rather than tracing out their own risk profiles,” he writes in The Wall Street Journal.

“This poses a real risk.”

Editor's Note: This Wasn’t an Accident — Experts Testify on Financial Meltdown

Schuermann, now a partner at Oliver Wyman's financial services practice, doesn’t think stress tests are all bad. They helped end the financial crisis in May 2009, he notes.

And “one unquestionably positive result is that banks have built up the capabilities to see how they would fare through different crisis scenarios,” dealing with everything from their deposits to their derivatives.

The problem now is that the “incentives to get close to the Fed's numbers are powerful enough to stifle genuine creativity, imagination and innovation by risk managers and their modelers,” Schuermann explains.

“Deviating from standard industry practice is now increasingly viewed with suspicion and often discouraged by bank regulators,” he adds.

“The danger is that the financial system and its regulators are moving to a narrow risk-model gene pool that is highly vulnerable to the next financial virus. By discouraging innovation in risk models, we risk sowing the seeds of our next systemic crisis.”

Some analysts were critical of the results of the stress tests released earlier this month. The Fed found that 17 of the 18 largest U.S. banks could withstand a deep recession and maintain capital above a regulatory minimum.

“The stress tests were just not very stressful,” Rebel Cole, a professor of finance at DePaul University, told The New York Times.

But others were more optimistic. “It’s a very good exercise to do, showing everyone that the U.S. banking system is well capitalized,” Gerard Cassidy, a banking analyst at RBC Capital Markets, told The Times.

Editor's Note: This Wasn’t an Accident — Experts Testify on Financial Meltdown

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