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Back in 2008, and in the aftermath of the troubles within the financial sector, a popular theme emerged about banks “privatizing profits while socializing risk.” To believe their critics then and now, banks swing for the proverbial fences with an eye on big bonuses, but if their careless ways lead to insolvency, their errors are cushioned by taxpayer bailouts. It was and is a neat theory, but not a very realistic one.
Back to reality, banks have shareholders who would prefer to not see the value of their investments crash. Because they would, banks and other financial institutions conduct “stress tests” on a daily basis. That they do speaks to the superfluous nature of Federal Reserve-enforced tests meant to verify balance-sheet quality within the institutions they regulate. They’re superfluous given the basic truth that banks have shareholders, and shareholders would prefer to see the value of their investments go up. Excessive home run swings are logically bad for shareholders for them imperiling the odds of the future earnings that wholly inform the value of their investment.