US Banks Recovering But Still Fragile

August 2, 2010 International Tax CooperationTaxation in USA

Twenties on WhiteThe US Government’s policy response to the 2008 financial market meltdown have counteracted the weaknesses within the banking system, but “pockets of fragility” still remain, which need to be addressed rapidly to mitigate further risks and Government costs.

The Financial System Stability Assessment report, prepared by the International Monetary Fund (IMF), was released on July 30th, and aimed to inspect the overall “soundness” of the banking and financial sector, judge the effectiveness of banks in upholding international risk standards, and evaluate the policies and safety nets instated for the industry. The Financial Sector Assessment Program (FSAP), the International Monetary Fund (IMF) division responsible for the report, also conducted bank stress tests, which aimed to evaluate banks’ potential performance in further economic downturns.

Overall, the FSAP deems the US Government’s currently debated banking regulations and legislation to be largely positive. However, a warning was issued that priorities should be given to the critical issues of strengthening and enforcing macro and micro-scale prudential regulations. Concurrently, legislative and fiscal policies should be considered to enforce discipline in the US credit market. In addition to national efforts, the US Government is advised to attempt guiding policy changes internationally, as inconsistent policy approaches by Governments across the world could lead to regulatory arbitrage and an escalation of fiscal instabilities.

The FSAP’s Bank Stress Test highlighted a small, yet persistent, shortfall in capital liquidity among US banks. Despite the significant improvement in banks’ capital positions since 2008, inadequacies could still arise in a hypothetical scenario of persistently high unemployment levels coupled with another economic downturn. Small and medium-sized regional banks were at the greatest risk, and could necessitate taxpayer funded capital injections if the economic climate deteriorates once again.

The low capital levels seen in small banks highlight the necessity of increasing cooperation and information sharing among US regulatory bodies, to mitigate the possibility of “spillover effects,” as seen in the 2008 financial crash. A collapse of the small banks sector, the property investment market, or even a vulnerable foreign economy could influence several US financial markets concurrently, necessitating the quick and coordinated efforts of several policy makers and regulators to lower the chance of a country-wide collapse.

Photo by Darrren Hester