Y’All Ready For This?

Banks ill prepared for recession

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What's going on?

The likelihood of a US recession in the next 12 months is at a 12-year high – and despite success in recent “stress tests”, banks may not be adequately prepared.

What does this mean?

A “recession” is when the size of an economy shrinks for two consecutive quarters. And while US growth is still ticking along nicely, the New York Federal Reserve believes that the chances of one happening soon are passing the historical point of no return. The NY Fed’s predictions have proven too conservative in the past – and so some investors think the probability of a recession is even higher than its estimated 33%.

Banks sit at the center of developed economies, and their ability to weather a recessionary storm is therefore crucial to any recovery. But while most global banks have successfully passed stress tests set up after the last financial crisis, the chair of the US Federal Reserve and European officials both said on Wednesday that those tests needed to get more rigorous in future (tweet this).

Why should I care?

The bigger picture: Banks may be in need of tough love.

Recent relaxations of stress test rules have arguably made it easier for banks to pass – and this could put them (i.e. you, {% if contact.FIRSTNAME %}{{ contact.FIRSTNAME|capfirst }}{% else %}Finimizer{% endif %}) at risk in the event of an economic downturn. Australia’s central bank may be ahead of the curve: this week, it asked banks there to increase the amount of money they hold in case of emergencies. Although those requirements don’t kick in until 2024…

For markets: Banks can rain on a market parade.

Banks are big employers – Bank of America has over 200,000 staff – and job cuts in a downturn could dramatically increase unemployment. And even if there is no recession, banks obliged to keep more emergency cash in reserve may be less likely to loan out what’s left. That could dampen demand for products and company investment – which would probably lead to depressed company earnings and stock prices. Bye-bye, S&P 3000.

Originally posted as part of the Finimize daily email.

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