Page 27 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

Banking: The Prisoner’s Dilemma BY MONOCLE RESEARCH TEAM
The results of the annual banking stress tests were published on the 23rd of June 2016, and there were many victims. e US Federal Reserve tested 33 institutions and three were found wanting. Two failed outright, and one was given notice. ese tests are based on hypothetical shocks that include negative interest rates, stock price declines, high unemployment and GDP erosion. e results are aggregated and the impact on capital and liquidity is assessed by the Fed. When a bank fails, that bank in theory should already be cognisant of its insouciance, since the thresholds are well understood.
Since the 2007 Financial Crisis, a plethora of new regulations were introduced by all countries falling within the aegis of the Basel Committee for Banking Supervision (BCBS). Because all banks necessarily trade cross-border and because the BCBS falls under the Bank for International Settlements, the BIS, which governs interbank cross-border settlement, banks, and in turn their governments, tend to comply. ose banks which fail, in spite of their status as non-governmental exchange-traded entities, are restricted from issuing dividends and paying shareholders as they please. Deutsche Bank, one of the two banks that failed the US tests, cannot be paid a dividend by its US subsidiary, at least not until its subsidiary has modi ed its balance sheet to the extent that it can pass the stress tests.
To be fair, all of this seems quite reasonable given the extent to which the Financial Crisis impacted US taxpayers, as well as taxpayers in many other countries. But the regulations go somewhat further than insisting on annual stress tests. e capital requirement itself has also been dramatically increased. Under Basel II regulations, rati ed in 2006, the total common equity portion of the capital requirement of risk- weighted assets was 2 percent. Risk-weighted assets is the concept the BCBS invented to mean the weighting of the balance sheet of a bank based on perceived riskiness. is equity capital requirement is now 4.5 percent under Basel III rules and can go as high as 7 percent. at is
“When a bank fails, that bank in theory should already be cognisant of its insouciance, since the thresholds are well understood.”
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