This Friday we are supposed to see the release of the bank stress tests by the government. In theory these tests are supposed to show how some banks are strong and help to build confidence in the system.
While the details of how the system will work remain sketchy I am not particularly confident about it. Admittedly I am far from being a banking expert but then again look at what the so called experts managed to do with the system so far.
The core of the problem for me is that I don’t see how it can help the more secure banks and I think it will kill the weaker ones. Depending on which scoring system they choose the damage could be moderate or quite severe.
Though they have not spelled anything out my assumption is that they have a rather detailed scoring system to decide which banks pass and which do not. They have likely analyzed overall deposits/assets versus liabilites, looked at the strength of the loans, stability of the overall company, etc to reach conclusions.
However this does not mean they will release the scores. They could simply go with a pass/fail scoring or they could release the more detailed numbers on something of a 1-100 system.
If they do the pass/fail system then pretty much any bank who is in the fail category is doomed. The investors on Wall Street will trash their stock, and while most of these stocks are already weak there is a difference between weak and dead.
Those with deposits in the bank will run like the wind to withdraw funds and pretty soon doors will be closing. It might take a few weeks or a few months, but dead is dead.
At the same time, the banks who did pass will not gain much from this scoring system because nobody will know if the bank barely passed with a D- or if they got an A. Basically those banks who were thought to be stronger will remain so and those thought to be weaker will remain so.
In short, the bad banks will be badly hurt while the good ones will not be helped a great deal.
If they actually release detailed scoring then it will be even worse because those banks with the lower passing scores will sink as quickly as the ones with failing scores.
The third option of course is for everyone but a few token banks to pass, but again that will do little to build consumer confidence.
Admittedly I am not sure I have a great solution to this problem but I am pretty sure the stress test proposal won’t help much, which is why I would not be surprised if they don’t release them.