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Have The Stress Tests Created Perverse Incentives?

The thing that worried me most when I read today's stress-test coverage was this from the Times:

What is more, any gains from asset sales, stock sales or larger-than-expected profits over the next two quarters can be used to offset the shortfalls. That might encourage banks to take bolder action, although some have struggled to find buyers for their businesses, or at least ones willing to pay the prices they seek. [E/A.]

Which is to say, banks deemed to be lacking in capital can lower the amount they have to raise by earning more money over the next two quarters. Am I the only one worried this is going to lead to all sorts of accounting games designed to goose profits during this time? It certainly wouldn't be unheard of in the banking industry...

In fairness, yesterday's Treasury-Fed guidance did obliquely suggest* regulators would take a skeptical view of this sort of thing:

[Banks] are encouraged to design capital plans that, wherever possible, actively seek to raise new capital from private sources. These plans should include actions such as ...

Conservation of internal capital generation, including continued restrictions on dividends and stock repurchases and dividend deferrals, waivers and suspensions on preferred securities including trust preferred securities, with the expectation that plans should not rely on near-term potential increases in revenues to meet the capital buffer it is expected to have. [E/A.]

We'll see how much they stick to that.

--Noam Scheiber

*I wish they would have addressed the issue of earnings directly, but this is as close as they came.