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Stress Tests and Managerial Distraction



The Wall Street Journal reports that Michael Corbat, the CEO of Citigroup, has a singular focus--ensuring that his bank passes its next stress test. The bank's failure of its most recent stress test last spring was an unwelcome surprise. The Journal reports that its failure was rooted in the qualitative portion of the test. Mr. Corbat is thus focusing on "courting the Fed" with visits; "passing next year's stress test [is] his 'Mission No. 1.'" How sad that a bank manager's overriding objective is to cozy up to his regulators so that they give him their blessing. Doing so might not even keep the bank safe. What if the regulators' focus is misplaced? As much as we want to believe that regulators are omniscient and unbiased decision-makers, they have limited information and sometimes miss things or exercise imperfect judgment. The Fed made supervisory missteps with respect to entities like Citi in the lead-up to the last crisis, and that is not surprising. Regulators simply are not able to collect and process information as quickly and effectively as necessary to be outside risk managers for the big banks. Moreover, as John Cochrane observed in a recent article, "[a] system more ripe for capture and a revolving door would be hard to design." Our regulatory system should be designed to encourage bankers to pay close attention to the challenges and opportunities faced by their institutions, not to keep their eyes fixed on every move their regulators make. Bank executives with their heads in the regulatory clouds are likely to miss important happenings on the ground.

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Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

 

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.