More Banks Passing Stress Tests, But is the Banking System Really Safer?Paul-Martin Foss
One feature of the post-crisis financial system that is supposed to make the system more resilient to shocks is the introduction of annual stress tests. These tests are supposed to model scenarios that might be seen during a financial crisis and assess the strength of a bank to withstand an economic crisis. Banks have responded to stress tests by strengthening their balance sheets, so that this year it is expected that all major banks may pass the tests. But does passing stress tests really mean that the banking system is safer?
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Teaching to the Test
The obvious flaw in stress tests is that banks respond to them by making changes that assure that they will pass future tests. But just like teachers teaching to a test means that students pass a test but don’t necessarily learn anything, regulators insisting on stress tests result in banks that pass the tests but aren’t necessarily going to be financially sound when a crisis hits. Sure, banks may have increased the amount and quality of capital they hold, but will that be enough to save them in a repeat of the 2008 crisis? And what happens if the next crisis is worse than 2008, are banks prepared for that?
Now that we are nearly a decade out from the financial crisis, the necessity of annual stress tests is being questioned. Treasury Secretary Mnuchin supports the use of stress tests every other year rather than annually and exempting banks with higher levels of capital from stress testing. We’re getting to the point where many people have forgotten all about the worst parts of the financial crisis. They think that the financial system is in great shape, that everyone has learned their lesson from the crisis, and that the economy will only get better from here.
Fractional Reserve Banking
None of the changes made by banks have changed the fact that the banking system is based on banks only holding a fraction of their reserves on hand to satisfy withdrawals or check clearing. In the event of a systemic crisis, it’s obvious that banks would have insufficient funds to stop bank runs. And relying on a government deposit insurance fund that is inadequately capitalized would just mean that taxpayers would ultimately have to bail out bank depositors.
Banks Still Failing
Despite the use of stress tests, banks that pass stress tests still fail. In Spain, Banco Popular passed its most recent stress tests but still failed earlier this month due to a bank run. The moral of the story is that stress tests are just theater. They are for public consumption, to keep public faith in the strength of the banking system so that depositors won’t withdraw their money and risk collapsing the system. If you leave your money in bank accounts, it’s not a question of if you’ll lose your money, but when.
Previous generations may have sought to save money for retirement by saving it bank accounts, but that’s no longer possible. Decades of loose monetary policy have pushed interest rates so low that it no longer makes sense to place money in savings accounts. Interest rates on savings accounts are next to zero, and they can’t even keep up with inflation.
Savers are far better off investing their money in gold. Gold keeps its value against inflation over time. An ounce of gold buys as much today as it did 100 years ago; a dollar bill not so much. In times of crisis gold not only retains its value, it increases its value. It is always highly in demand as a store of wealth. And with a gold IRA, you can benefit from owning gold while also enjoying the tax advantages of a conventional IRA. If you still have money in the banking system, why risk losing it all to a failing bank? Keep your money safe by investing in gold.