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  • Writer's pictureWilliam Webster

Stress testing – a flawed approach

In banking stress testing is in vogue. But how effective is it? For engineers the bar on safety is high after all life itself is at risk. But in banking behavioural problems (people and markets) make things difficult to model. Indeed banking has been and always will be risky. Trying to eliminate risk will just make finance very expensive to undertake. This creates a conflict of interest. Cutting corners reduces costs and boosts profits (and remuneration). Furthermore in an indirect way behavioural issues provide the “get out of jail card” for those in charge whether they are regulators, central or commercial bankers. In this respect no one carries the can. We should therefore be very careful with our use of stress testing and how it applies to banking. It fails to model how things really work and it is riddled with conflicts of interest. The real value of stress testing is surely to challenge management flexibility and that’s about it.

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