How resilient are the banks?

WHEN FINANCIERS and governments redesigned the financial system in order to make it safer after the debacle of 2007-09, most of them imagined that a shock as bad as the subprime fiasco would be a generation away. In fact it arrived only a decade or so later. Lockdowns have led to a savage recession that is expected to produce huge loan losses as firms and households suffer.

So are too-big-to-fail banks really safer? The latest stress tests conducted by the Federal Reserve suggest the answer in America is “yes”. On June 25th the Fed released the results of its annual exercise, which compares banks’ buffers with the losses they would face in a downturn. In a pessimistic “U-shape” scenario, in which the economy faces prolonged social distancing and repeated outbreaks of the virus, the Fed reckons that banks would face total losses of over $700bn on their collective loan book. The hit is well above the worst case of $465bn that was envisaged in 2009, when the Fed did its first stress test. This year’s scenario implies cumulative losses on loans of about 10%, above the 7% loss rate actually experienced during the subprime crisis.

Happily, the Fed concludes, in this U-shape scenario the banking system’s total core-capital ratio would fall from the present 12% to a still-passable 8%. Some banks might have to limit the...