Invitation to a Party ... bring your Stress along !!!

Everybody is invited again …… to another Stress Test Party!!

So here we go once more, and whichever way you look at it, the Emperor has no clothes! The ones being really stressed in all this are the Regulators, and of course the markets, you, and !

I have an interesting email from Ash Jaidev, Northwestern University, (Class of 2012 Economics and History)

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I was reading some article and thinking about bank stress-testing overall, and had some thoughts.

So Europe is in the process of developing stress tests for its banks, and there's all this talk about whether those tests are going to adequately reflect the nature of these banks… My problem is this. Let's suppose that there are 10 banks being tested, and all 10 banks "pass" the test. Everyone will think that the regulators' test was inadequate and didn't do enough to challenge the banks, and therefore no one will trust the test.

Now let's suppose that the same 10 banks "fail" the test. Can anyone conclude that the banks are actually all terrible, or that the test itself was too challenging and nit-picky?

What if a bank peforms badly on a stress test: market value and confidence in the bank declines, the bank suffers. The failed test caused the bank to decline, but the bank wasn't declining when the test failed it. Isn't that a paradox/endless cycle? What caused what?

Not sure if I'm being clear with all this. Point is, there is too much responsibility on behalf of regulators to create a stress test that adequately challenges banks while also managing expectations of investors and the market. It seems to me that it is impossible to do both!

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Cheers