Stress test, anyone?

Mar 03, 2009 Editorial

The US economy is in trouble. Americans know this very well, because in every quarter various institutions are mandated to issue reports on the several indicators that define the state of an economy. So they know, for instance, that their country has plunged ever deeper into recession with the loss of 524,000 jobs in December, bringing to 2.6 million the total job loss for the year, the largest annual total since World War II. This job loss has pushed the unemployment rate to 7.2 per cent of the labour force.

They know, too, that at the heart of the crisis are their banks and other financial institutions, which are stuck with an estimated US$2 trillion (yes, trillion) debt of “toxic” assets.
While they may have reservations on the specific approaches to “fixing” their banking sector, Americans understand that, as the provider of credit to the entire economy, fix it they must – and urgently. In the stimulus plan he presented last week (and which we critiqued yesterday), President Obama has made provisions for another injection of cash into the beleaguered banks, but not before insisting that they undergo an immediate series of “stress” tests.

What these tests do basically is to not only examine the books of the banks to ensure that they are complying with the regulations that are in place but, more importantly, they check if the banks would survive to be in a position to service the economy if conditions deteriorate beyond what is defined as a “borderline” scenario.
The computer simulations would check the banks’ responsiveness to deal with, say, a 10 per cent unemployment rate or a further 25 per cent fall in home prices.
While not perfect by far, the results of the tests would at least provide some guidance to the new administration so that they do not just keep throwing money blindly at the problem – while keeping their fingers crossed.

In Guyana, while there have been questions about the specific numbers that have been thrown out about the state of our economy, even the administration has conceded that “thing na regula”.
In the meantime, the financial crisis that emanated from the US has caught up with us through CLICO’s opportunistic fishing in the same troubled US housing market that brought down its far more massive American cohorts.

We have a similar situation in which financial institutions have been allowed to stray far from the old prudential standards that once governed the arena of financial intermediation.
Even though hopefully in a paler imitation of the attitude that had become de rigueur up north, the quest for ever higher returns locally have created grave doubts, not only about the fate of CLICO’s and NIS’s clients but about the health of our entire financial sector.
While we are sure that all Guyanese appreciate the warrants about the “stability” of our financial institutions from our captains of industry and Ministers of State, they have become jaded after being frankly lied to by at least one “big one”.

The Government should also be wary about these asseverations – and for similar reasons as in the US. Whether they want to or not, the Government will ultimately be forced to clean up the mess created by the greed of the wheeler-dealers in the financial sector.
The probable loss of NIS funds is only the tip of the iceberg. We do not have the funds to throw around willy-nilly.

We recommend that the government orders stress tests not only on our banks but on all financial institutions, since they have all been permitted to solicit funds from the general public and to invest those funds.
Such tests should better expose the actual financial positions of these institutions, and perchance reveal whether there is a need for regulatory reform of the sector as we have been suggesting for some time now.
Finally, by specifying some “worst-case scenarios” against specified benchmarks, the Government might be alerted to some possible interventions it might have to make in the near future to facilitate delivery of its prediction of a three per cent plus growth in GDP this year.
We hope that the Bank of Guyana, which should conduct the tests, has the necessary human and software resources.

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