What do Stress Tests REALLY Mean for Banks?

What do Stress Tests REALLY Mean for Banks?

We have heard of the term. How important is it in the financial picture? After all, much of what comes from the regulators in Washington these days can be taken with a grain of salt.

Stress Tests are actually a combination of individual tests. They can entail for example, bank loss estimates measured as percentages of their holdings on first-lien mortgages, and second-lien mortgages, or credit cards and commercial real estate loans. Estimated bank earnings are also considered.

Then to this hodgepodge of risk percentages the reserve status of the banks are taken into account. The level of what is referred to as Tier 1 capital is important. This includes common and preferred shares, preferably equal to 4% of what is called risk-weighted assets. Sometimes that 4% may be considered too low.

To complicate matters, some unrealized losses on assets could become losses in the future, so the Tier 1 weightings may have to be adjusted with time. Obviously, Stress Tests are not fixed so their results can give varying interpretations.

And that is the basic fallacy behind the Stress Test talk you get out of Washington. It is far too much about subjective, theoretical nothingness. And it is the reason why the Big Regulatory Boys are running what has been a conventional economic recession into an economic depression.