The goal of regulators since the financial crisis has been to create a safer financial system. The need to overhaul the way Wall Street worked was obvious. But is it possible the banking system is now too safe?
Hamilton Place Strategies, a Washington-based consultancy, has created a new measure of the financial health of Wall Street. The Hamilton Financial Index combines the St. Louis Fed’s Financial Stress Index and the Tier 1 Common Capital Ratio for commercial banks to provide what the reports author, Matt McDonald, called a “snapshot stress test.”
The banks pass the Hamilton Place stress test with flying colours. On the left, you can see the key graphic from the report.
At the end of 2011, the index was 1.15, down from a peak of 1.24 in the second quarter of last year. The current reading is 15 per cent above the historical norm. Banks’ ratio of loans to deposits is about 73 per cent, compared with an average between 2000 and 2008 of about 89 per cent. If the financial system buckled today as it did after the collapse of Lehman Brothers in September, 2008, banks would probably be able to absorb the impact without the government’s help. Whether it’s the result of new financial regulations, or the result of decisions executives made on their own, the financial system certainly appears to be safer and sounder.
A collection of financial industry groups commissioned the HPS study, but there’s nothing in the report to suggest bias. Mr. McDonald, a former consultant at McKinsey & Co. who advised President George W. Bush, simply crunched the numbers. Mr. McDonald said at a presentation in Washington Tuesday that his goal was to create something that busy political staffers could distill without the luxury of time and a background in finance. One can imagine the Hamilton Financial Index showing up on both sides of the current regulatory debate.
For the bankers, they now have a fresh piece of evidence for their claim that Wall Street has learned its lesson from the financial crisis. The supporters of stricter financial regulation can use the report as evidence their efforts to tighten Wall Street’s leash are working.
But a financial stability index is not one that anyone should want to keep climbing higher and higher. “A bank that is 100 per cent safe and sound is not a bank,” said Mr. McDonald. It’s a safe.
So at 1.15 is the Hamilton Financial Index too high? Possibly, according Mr. McDonald. He said his index shows that banks are much stronger and poised to resume lending. But they remain in a “defensive posture,” he said.
Policy makers have done an excellent job at upending Wall Street’s run-and-gun approach to banking. Their next challenge could be breaking lenders out of their defensive trap.