Bank Stress Test

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Maybe stress the stress test.

In this weeks P4Capital discussion, the executive team continues to talk about something most of us try to forget – the great recession of 2008.

In a follow-up to the stunning news of all the American banks passing part one of the stress test we have some bad news – a few banks didn’t in fact pass part two.

The P4Capital team investigates what this means, and how it will protect the world economy should the worst come to pass again.

Stay tuned.

Transcript


Amanda: So much for our winning streak. Several american banks couldn’t hold it together in the final inning, and failed part two of the stress test. The P4Capital team continues their discussion about what these results mean for the future of the economy, and what these banks are going to do about their failing grades.

I don’t think they can simply apply for extra credit.

Jeremy: All right, this week we’re doing part two in our Stress Test series. A couple of big European banks just failed the Stress Test in New York – Deutsche bank and Santander of Spain.

Archana: Apparently even Bank of America just received a conditional pass. This was part two of the stress test which actually happened last week, in which all of the 31 banks were cleared. Part two was essentially in order to assess their terms of raising capital by way of dividends, and these two banks essentially failed.

Jeremy: Bank of America’s actually going to try to do about 4 billion dollars into share buybacks, which they got the green light on. So Deutsche bank and Santander are going to face penalties where they can’t do any share buybacks right now, or raise dividends, but they’re still able to issue the dividends as they stand

Amanda: What does part two entail?

Shaheerah: Well it’s called the Comprehensive Capital Analysis and Review, CCAR. And basically these banks that failed, now they have to make some changes in their plans or they could have to pay some financial penalties. Basically, it prevents these US entities of the foreign banks from distributing any capital to their parent companies.

Jim: With that said, the question Amanda asked was what does this all mean? It means basically that the United States has said that either you’re going to have enough cash to be banking in the US, or you’re not going to bank in the US. As simple as that. They want a very strong and healthy financial system to spur their growth into this new age of technology meeting business and new entities being created, which should sustain their economy for the next three to five decades.

Archana: I’m just curious to hear the thoughts of the P4Capital team here – do you think the introduction of these stress tests and various levels of scrutiny – what do you think about another 2008 like meltdown? Do you think we could avoid another one of those again?

Jim: Not a chance. As the elder statesman at the table by a considerable factor so, I have seen these financial games in various shapes and forms over four decades, well – let’s call it five. And there will be a new game at hand somewhere, sometime in the future, but the objective here is to get stability for at least a 10 year run, and then let the governing bodies a decade out from now worry with what’s on their plate at that point in time. But quite bluntly, we’re in full economic recovery right now Archana, but it is so tender. It could not support another meltdown of the magnitude that was unprecedented by the way, that happened in 2008.

Archana: I would actually agree with Jim. To me, the only constant there is change. And we’ve all witnessed this within the Capital Markets environment. Yeah I mean, this is a way for stabilizing the marketing and the economy as it stands right now, but 10 years from now something else might just crop up and the regulators at that point will try to put checks and balances in place too.

Jim: The interesting part about these Stress Tests, that’s probably also illustrative to all those other financial institutions is the absolute weakness of the underpinnings of technology. I had this discussion last week with a senior banker in downtown Toronto, and we talked about their base engine technologies, which was something that the group 20 years ago installed. So now, you’re trying to run a multi trillion business using ancient, antiquated technologies. It should be very interesting as they continue to work on stress tests to see if these banks, in this case the group of 31, are going to be able to sustain it in the future or not.

Jeremy: I think what caused the financial meltdown revolved around derivative products; credit derivatives, swaps, CDS’s they were called. That was-

Jim: MBS’s

Jeremy:-right, mortgage-backed securities. Basically predicated on the fact that banks were issuing mortgages to just about anyone with a pulse, and then bundling those mortgages off as fast as they could into securities. There were three different levels of risk – they were called trenches. The lowest trench were all sold at one price – medium. They had another price – the top-level; senior level they were called. Wasn’t even that much of a risk premium that companies were taking – companies such as AIG — and there ended up being massive defaults across all three levels of risk. Lots of problems there, and here we are six years later or so, and there is still not a clear picture of what risk looks like on balance sheets, especially in the derivatives business which is largely unregulated. There are lot of measures to see how they can measure this risk better, but we’re not there.

Jim: Yeah, but that’s symptomatic Jeremy. You know any time you try to modernize debt you’re running risk, full stop. Debt is debt. But the interesting part were the reverberations in the marketplace of 2008, and how it brought the global economy down to its knees, almost overnight. So, I look at it again and say can that game of taking, using your words – providing debt mortgages to anyone who can apply – is that going to be game on in the future? I doubt it

Jeremy: It will be a different game

Jim: Maybe it will be a different game, absolutely! We don’t know what that will be.

Jeremy: Maybe it’s going on already?

Jim: I would suggest it probably is, going on already.


 

That was the P4Capital team discussing the Stress Test, and what these failing grades mean for the banks going forward. Want to know more? Check out our website  and previous posts at www.planet4it.com or follow us @p4capital. Thanks and see you next time.