Stress Testing of Commercial Banks vs. Investment Banks

During the depths of the recent financial crisis, the Federal Reserve formalized a concept relatively new to most bankers — stress testing. This new form of testing was publicly performed on the 19 largest “banks” in the country. All 19 passed, although a few showed some signs of weakness. Most that showed weakness were not really commercial banks, but investment banks — two very different types of organizations.

Not since that first public stress testing of the largest financial institutions have we heard much more about it, though stress testing has begun to creep into the vernacular of all sizes of banks, including community banks. It is often discussed in tandem with enterprise risk management (ERM). Although I agree that ERM can be a useful tool for bank management, forcing it upon community banks is tantamount to killing mosquitoes with a sledgehammer.

Back to stress testing. Late last week, the Federal Reserve reported the results of the latest round of stress testing, this time for the 18 largest financial institutions. Interestingly enough, 17 of the 18 passed. The only one to fail was Ally Financial. Ally is not a bank in the sense that most people would think of banks. Ally was the old GMAC – the auto financing arm of General Motors. During the financial crisis, GMAC obtained a bank charter, changed its name and received billions of dollars of Troubled Asset Relief Program (TARP) funds from the U.S. Department of the Treasury. Not only was General Motors bailed out by the questionable use of TARP funds, but so was GMAC. But it’s not a traditional bank.

Also during this latest round of stress testing, the Federal Reserve determined two other organizations were weak, even though they technically passed their stress tests.  These organizations are Goldman Sachs and Morgan Stanley. Both of these financial institutions are investment banks, not commercial banks. Commercial banks are what the general public thinks of when they think of banking, bankers and banks. Noncommercial banks, such as Ally Financial, Goldman Sachs and Morgan Stanley, sadly sully the historic good names of banking, bankers and banks.

I shudder to think that the publication of these latest stress test results will bring about another round of anti-bank sentiment from the all-news-all-the-time cable television stations, consumer groups and certain elected officials. I fear that banks will be castigated once again, when the truth is that traditional commercial banks and thrifts all passed their stress tests with flying colors. In fact their capital levels have increased by 25 percent since the first stress tests. These are astoundingly positive results that the public will never be told about.

I am surely feeling the stress, and I don’t need a test to tell me!

One Response to Stress Testing of Commercial Banks vs. Investment Banks

  1. Mike Cahill says:

    Joe, I have a thought for the next board meeting. Many times I post these through my own LinkedIn page. If our board members (who are on LinkedIn) posted many of these, the word would get out even further. Worth discussing?

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