Year after year, the same ritual unfolds: financial supervisors and regulators – sometimes national, sometimes supranational – assign their subjects labour-intensive tasks to be quietly completed, and submitted on time over weeks and months. Afterward, the supervisors examine, analyse, calculate, and assess these results, equally quietly and undoubtedly just as laboriously. Ultimately, they publicly announce the findings – aggregated, without naming names, and accompanied by the assertion that the financial industry as a whole is solid, resilient, and healthy. But here comes the significant caveat: this fundamentally satisfactory assessment can change rapidly.

A period of calm follows the stress test – until the next one comes along. The process generates substantial work and costs for banks, raising questions about its purpose. Depending on the assumptions underlying the negative scenarios, the impact on earnings and capital depletion varies in intensity. As a result, the accusation of arbitrariness is sometimes made in financial circles. One might assume that the supervisors put considerable thought into developing their scenarios. The outcomes provide insights into where the financial system is struggling, and raise awareness of potential negative developments. When deficiencies become apparent, regulators scrutinise more closely, or demand higher capital buffers.

Overall, this approach is sound and justified. However, doubts within the industry regarding the cost-benefit ratio, and the general validity of stress tests, are valid concerns. Moreover, the assumptions can quickly become outdated, as seen in 2022 when the repercussions of the Ukraine war rendered them obsolete. Additionally, stress tests offer little insight into the quality of management.

A prime example of how quickly seemingly solid institutions can falter due to governance weaknesses – despite strong capital and liquidity ratios – is Credit Suisse.

The regulators have recognised these weaknesses and are attempting to act more swiftly, while also aiming to reduce the burden on smaller institutions. Nevertheless, some have indicated in the past that they wish to tighten regulations further. As a result, large banks will need to prepare for even more frequent and rigorous assessments.