BNP Paribas - What To Expect From The Stress Test?

As we discussed in our recent scenario, the US authorities have the necessary tools and margin for manoeuvre to resolve the banking crisis. The remaining risks are primarily execution risks (insufficient or ineffective private sector incentives and poor communication). It is also certain that the ultimate cost for the taxpayer will be extremely high.

The banking system stress test is part and parcel of the new Administration’s financial stability plan. It will not solve the problems of the banking system once and for all. At best, it will give a snapshot of banks’ capital requirements, based on conservative, but not extreme, assumptions. But the stress test should help restructure the banking system swiftly and efficiently, i.e. favour asset disposals, recapitalisations, mergers and/or liquidations.

That said, there are still many uncertainties relative to the contents of the stress test. We discuss them here according to three themes:

1. The method and level of stress adopted by regulators. Assumptions regarding the economic outlook appeared pessimistic enough in February, but are now closer to the consensus. Nevertheless, the stress estimates for loan portfolio losses may be greater than suggested by macroeconomic assumptions, as revealed in the press this morning.

2. Whether or not to disclose detailed results for each bank. The Treasury is more in favour of disclosing results for individual banks than the regulators are. The advantage would be to identify banks deemed as robust and those considered to be undercapitalised, hence lifting uncertainly and speeding up restructuring of the banking sector. The risk would be to trigger panic selling of stocks in banks deemed insolvent; this risk could be contained by the concomitant announcement of capital increases (public or private).

3. The Treasury’s capacity to recapitalise the banking system single-handed. The IMF’s recent estimates are a useful reference. The public funds already released would be enough in a relatively favourable growth and leverage scenario, but insufficient in grimmer conditions.