Stress tests aren't perfect, but they're the best we've got


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The Independent Online

It’s worth noting that the banking industry has just as many critics on the right as it does on the left, particularly the free market loving part of the former which decries what President Obama once described as the industry’s “socialised” losses.

Enter the Adam Smith Institute, with a report entitled “No Stress: The Flaws in the Bank of England’s Stress Testing Programme” penned by Kevin Dowd, professor of finance and economics at Durham University.

While it warns that banking is still in a mess, its target, as you might guess from the title, is as much the industry’s watchdog as it is the industry. And it isn’t altogether fair. The report, for example, calls for the Bank’s stress testing programme to be abandoned, and for reformers to focus on the restoration of sound accountancy standards – as if that might, by magic, fix everything.

It is also hard to support its thesis that the Bank is asking people to believe that there are no icebergs lurking that the industry might hit. The last set of stress tests arguably found some, and forced Lloyds, RBS and Co-Op to bolster their capital buffers as a result.

It is true that the tests have their flaws, and it is impossible to guess accurately the next set of nasties the global economy may throw up. It may also be true that the banking industry is still undercapitalised when it comes to dealing with them.

Unfortunately, we are now seven years out of the crisis, and the game of regulatory arbitrage has begun anew with a certain HSBC, that has been grousing about many of the Bank’s reforms, in the driving seat. Moreover, its tactics appear to be paying off, given the conciliatory noises that have been emerging from the Government.

Despite what the Institute says, the Bank, and its stress tests, are probably the best we can hope for. So long may they continue.