What bank stress tests don’t tell you about banking system resilience | New Economics Foundation.
The Bank of England has just released the results of its first ‘stress test’ of UK banks, designed to assess whether they have enough capital to weather a severe financial storm. While headlines have focused on the fact that the Co-operative Bank failed the test, policymakers and regulators are claiming the overall results show their reforms are working, and that the system is now more resilient against future shocks.
But when policymakers claim this, they’re making an implicit assumption that the resilience of the system equals the sum resilience of all individual banks. They’re also assuming resilience can be understood purely in terms of the size of banks’ buffers against shocks, rather than their inherent tendency to generate those shocks in the first place.
As the financial crisis taught us, things are a lot more complicated in reality. Even if the stress tests show individual banks are now ‘resilient’ (a big if, given that Lloyds and RBS only just scraped through – and that the real impacts of any future shock are inherently uncertain), does that mean the same is true of the system as a whole? Not necessarily.
We need to consider the system as a whole
For one thing, economists are starting to learn what ecologists and engineers have known for decades: that the same components can be assembled into a more or less resilient system depending on how they’re connected. Stress tests purport to show what might happen to an individual bank in a stress scenario, but they don’t fully capture the ways in which that shock might rebound around the system.
