Stress tests 'are not a real guide to coping with crises'

BANK stress tests fail to measure how those institutions will deal with genuine financial crises, Bank of England policymaker Paul Fisher warned today.

To be properly valuable, the tests need to take greater account of how rare, global events will hit balance sheets, he argued.

In a paper co-authored with Patrik Edsparr, a visiting fellow at the Bank of England, Fisher said investors and regulators need to have a better idea of what would happen to banks were extreme "tail risks" to materialise.

"Comparable, tail-event stress tests could be an important piece of the information set that investors and regulators analyse to determine the relative value and risk profile of the institution," he argued. He also seems to think such events are likely to be so damaging the banks won't survive them without assistance.

"Highly leveraged institutions such as banks and hedge funds are not really suited to be the ultimate repositories of extreme tail risk," Fisher said. Pension funds, insurers and other "real money" investors are better suited to absorb losses from rare shocks, he said.

"Virtually all risk management had been done within a 'local' framework, rather than genuinely extreme stress tests," the paper said.

"If regulators, rating agencies or, for that matter, bond and equity investors had demanded analysis based on extreme stress tests, many of the repercussions in the system could have been identified."