Quelle Surprise! Banks Overestimating Their Health

Remember Lake Woebegone: all the women are beautiful, and all the children are above average. And all banks in robust health.

Self assessment (and undue self regard) was one of the big fallacies of the famed stress tests. The banks were asked to run scenarios on their own loan portfolios, with no independent verification of what was in them (as in no sampling of loan files, for instance). And on the trading side, the tests were run using the banks’ own risk models, which as we all know did a wonderful job in the run-up to the crisis.

Not everyone is convinced. The Financial Stability Board, a group of international regulators tasked with developing new international banking standards, ascertained that many of the 20 biggest banks are too optimistic about their health and warned against letting them exit close government supervision too soon. From Bloomberg:

“Some banks became dependent on this assistance and don’t seem to be able to detach themselves from the public support,” FSB Chairman Mario Draghi told reporters today after a G-20 meeting in St. Andrews, Scotland. “Some jurisdictions may continue to support unsustainable business models.”…

“While firms indicated that they had either fully or partially compiled with the most recommendations, the Senior Supervisors Group members found that these assessments were, in the aggregate, too positive,” said the FSB. “Much stronger ongoing management commitment to risk control” will be required to close the gap.’’….

Finance ministries should be wary of institutions wanting to exit the programs too quickly, the FSB said.

“Authorities may want to delay exit in order to preserve their freedom of action in case conditions again worsen,” the report said. “A terminated program that subsequently needs to be reinstated could undermine the broader credibility of the official sectors’ policy response.”