So the last test only measured whether or not Wall Street had enough gas in its car. The next test is where we find out if Wall Street can drive.
On Thursday the Federal Reserve announced that 31 banks passed the first party of their annual two part stress test. Wall Street gave itself a golf clap.
Unfortunately, that first part of the test doesn’t mean much for the banks in the way of their ability to survive the next financial Apocalypse.
To understand why you have to understand the way the stress test is structured.
Each test is a different financial disaster. This year’s happened to be a scenario in which corporations started defaulting on their debt.
So there’s your first caveat right there — a bank t if it doesn’t have a ton of corporate debt liability on its balance sheet.
Then there’s then fact that this test is in two parts. On Thursday we saw the results of Dodd-Frank Act stress testing (DFAST). On March 11 we’ll get the results of the Comprehensive Capital Analysis and Review (CCAR) test.
DFAST just tests to see if you have enough cash to survive the particular disaster scenario the Fed dreamed up. The only question is — is this bank adequately capitalised?
But there’s way more to surviving a financial disaster than being capitalised, and that’s what CCAR tests for. To survive a financial end of days, a bank has to have good risk management, streamlined compliance operations, and a bunch of other qualitative processes and controls in place.
That’s what CCAR tests for, and that’s where banks fail. That’s where Citigroup failed last year. And when a bank fails CCAR, the Federal Reserve won’t let it buy back shares or pay out dividends. Naturally, this really annoys shareholders.
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