Money, Banking, and Financial Markets

Understand the principles, understand the future

The Federal Reserve’s annual stress test is the de facto capital planning regime for the largest U.S. banks. Not surprisingly, it comes under frequent attack from bank CEOs who argue, as Jamie Dimon recently did, that “banks have too much capital…and more of that capital can be safely used to finance the economy” (see page 22 here). From their perspective, this makes sense. Bank shareholders, who the CEOs represent, benefit from the upside in good times, but do not bear the full costs when the financial system falters. As readers of this blog know, we’ve argued frequently that capital requirements should be raised further in order to better align banks’ private incentives with those of society (see, for example, here and here).

A more compelling criticism of central bank stress tests focuses on their discretionary character. To the extent feasible, central banks should minimize their interference in the allocation of resources by private intermediaries, allowing them to direct lending to those projects deemed to be the most productive.

But the painful lessons that have come from large asset price swings and high concentrations of risk provide a strong case for the kind of limited discretion that the Fed uses in formulating its stress tests. This blog post highlights why it makes sense for regulators to use this year's stress test exercise to learn how well the largest U.S. intermediaries would fare if the recent commercial real estate price boom were to turn into a bust....

Guest post by Professor Lawrence J. White, NYU Stern School of Business

Overshadowed by the media attention to the proposed repeal of Obamacare, the House Financial Services Committee recently approved substantial changes in financial regulation. The House of Representatives may soon consider the proposed bill—the Financial CHOICE Act—which would make major changes in the Dodd-Frank Act.

However, when financial regulation is being discussed, there is a large elephant that isn’t in the room, but really should be: Walmart. Starting in the mid-1990s, Walmart made two separate efforts to enter banking in the United States, but was repelled both times. After its second effort was rebuffed in 2007, Walmart gave up this effort in the United States (but has since entered banking in Canada and in Mexico).

One question to ask might be, “Why should Walmart be allowed to enter banking?” But a more relevant question would be, “Why shouldn’t Walmart be allowed to enter banking?” ….

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... the site where you can learn about finance and economics. We provide commentary on events in the news and on questions of more lasting interest. Because the financial system is constantly evolving, our analysis is informed by a set of core principles: understand the principles, understand the future. The opening excerpts of our two most recent posts appear above. For prior posts, click on the Commentary link to the left, or on the month-by-month Archives to the right. Alternatively, if you are interested in a specific topic, use the tags.

The site also provides material related to our textbook, Money, Banking and Financial Markets, 5th edition, 2017. The Five Core Principles on which the book is based are highlighted here. In addition, Cecchetti and Schoenholtz 5e systematically integrates the use of economic and financial data from FRED, the online database provided by the Federal Reserve Bank of St. Louis. Click on FRED Lessons on the left to access help on how to use this incredible resource.

Steve Cecchetti and Kim Schoenholtz

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