Implications of the Bank Stress Tests

Douglas J. Elliott
Douglas J. Elliott Former Brookings Expert, Partner - Oliver Wyman

May 11, 2009

The results of the “stress tests” on the 19 largest banking groups were released at the end of last week. They were good news and were generally received as such, although it is important not to take excessive comfort from what remains essentially a highly educated guess as to the future of the banks in a very uncertain environment.

The test appears to be somewhat tougher than the base case of the International Monetary Fund (IMF), but not nearly as harsh as the most pessimistic analyses. This implies that while we may well have turned the corner, we can be far from certain that the solvency crisis in banking is over. Even if it is, the stubborn credit crunch will last for considerably longer. The banks will be in a better position to lend more freely as a result of the modest influx of new capital and the greater benefit of the confidence boost from passing the tests. However, the depth of this recession and the shattering of the securitization market will keep credit tight for some time.

This paper will address the following questions:

  • How tough was the test compared to other analyses?
  • Is the banking crisis over?
  • Does it really do any good to shuffle the capital between preferred and common stock?
  • Will the banks have enough capital to lend more freely?
  • What does this mean for the programs to deal with toxic assets?