Tough stress tests created by the U.S. Federal Reserve offers some comfort to stressed investors.
The stress tests which were created by U.S. regulators in the wake of the 2008 financial crisis could prove their worth in the wake of Britain’s decision to leave the safety of the European Union, since it will allow the capture of the hardiness of British banks caught in the midst of turbulence.
The U.S. Federal Reserve has disclosed that it will release a second set of results from such stress tests, which it conducts annually on large banks since 2009, sometime tomorrow.
The stress tests provide an inside peek on the performance of banks during unforeseen scenarios such as economies in free fall, stock markets tumbling down a chute with no bottom in sight and market counterparties at risk of failure.
Although the stress points may have been dreamed up by the U.S. Federal Reserve, the results could however reassure investors on the bank’s risk exposures. This could be applied to Britain’s shocking decision to leave the EU and its tumultuous consequences that its economy is facing.
“This is a real-world test that can help demonstrate the greater resiliency of banks’ balance sheets and the benefits of de-risking that, while having hurt revenue this decade, should help incrementally in times such as this and show the relative strength of U.S. banks,” said Mike Mayo a bank analyst.
For investors, it may be comforting to know that the U.S. Federal Reserve’s stress test scenarios are much tougher than anything the banks have so far faced as a result of Brexit.
According to standardized stress tests, the Feds modelled for the stock market to lose half of its value and unemployment surge to 10%, among other factors.
The results of the stress tests have been released last week comforting investor concerns. They have not only been tailored to individual banks’ business models but also judge the quality of their planning process.
In response to rising investor concerns, analysts at Goldman Sachs have issued a report on yesterday, which showed Brexit’s impact on the earnings across the U.S. financial sector next year.
Analysts have noted that they have modelled Brexit’s downside scenario for “for illustrative purposes.” only.
“Our current GS estimates do not incorporate these theoretical scenarios as a forecast,” said Richard Ramsden, an analysts at Goldman Sachs.
According to Mayo, the U.S. Federal Reserve is likely to allow U.S. banks to shore up their capital reserves so as to better deal with the fallout of the British referendum.
Yesterday, European bank stocks got hammered with the regional index falling by almost 8%. In comparison the U.S. bank index fell by only 3.2%.
Not a 2008 scenario
The results come at a time when U.S. Republican presidential nominee, Donald Trump, and other lawmakers, are hoping to dismantle financial reform regulations that formalized stress tests and other rules to make the system stronger and safer. As a result of the Dodd-Frank reforms, U.S. banks are much better suited to handle market shocks like the ones created Britain’s referendum.
Although many banks have begun operationalising some of the plans as the UK prepares to leave the European Union, making the move too soon could be costly.
“This will be a long, drawn-out process that will take several potentially nuanced turns,” said Gerard Cassidy along with analysts at Royal Bank of Scotland in a report detailing Brexit’s impact on big banks.
Big banks have already bet that the “financial passport” which allows them to trade, lend and execute deals effortlessly from the U.K. through continental Europe will be now not be accessible anymore.
Many banks have already hatched contingency plans which includes relocating operations and staff to countries like Dublin, Frankfurt, or Amsterdam. Also many banks foresee a period of low interest rates and strong headwinds in the loan segment, globally, all of which could cost them a pretty penny.
Analysts are already preparing reviewed revenue estimates so as to issue new reports this week.
By and large, analysts opine that it would be best if investors buy bank stocks whose decline doesn’t line up with reality.
“As has been the case at times of global shocks since the fall of Lehman Brothers in September 2008, some have asked whether Brexit is another ‘Lehman moment,’. We do not believe so,” said market analysts at Goldman Sachs.