If this year’s bank stress tests were graded on curve, Wells Fargo & Co. would be at the bottom.
It didn’t fail. No bank did. For the second consecutive year, all of the banks examined were able to survive the Federal Reserve’s hypothetical worst-case economic scenario, according to results of the first round released on Thursday. Next week, the Fed will examine the banks’ own capital plans and approve or reject their proposed dividends and buybacks. That portion of the test, given that the economy is not in a recession, has become more significant than the first round.
But on this portion of the test, nearly 10 years after it was introduced, it’s not clear “passing” is the right benchmark for success. Nor is it how high a bank scored above the minimum set by the Fed. The best measure is how much effort was required to pass. Wells Fargo had to cram the most — another fallout from all of its problems in the past year.
Risk in the banking system can be measured in any number of ways. One is to look at how much banks will lose on soured loans and bad trades during an economic downturn. This year the Fed estimated that in a severe economic downturn the largest U.S. banks would lose a collective $578 billion. That’s up from last year’s estimate of $493 billion, though it does appear that the test’s economic scenario was more dire this year. The biggest loser was JPMorgan Chase & Co., with losses of $93 billion, followed by Bank of America Corp. with $72 billion and Wells Fargo with $70 billion. Morgan Stanley, which is still a relatively small lender, would lose only $22.4 billion.
Another way to measure risk, and the one that has become standard since the financial crisis, is to look at how prepared the banks are for those losses. That’s what people are talking about when they say the banks are much safer than they used to be. One gauge is money the banks have already set aside to cover bad loans, called provisions. Based on that, the big banks, as I wrote recently, look pretty risky. Those reserves have shrunk close to the level they were before the financial crisis.