Be careful about trusting "Stress Test" and other quality controls of our banking system

I have started listening to financial news radio & TV in the past year, as they have guests come on brief segments that give out information that you never see in written media on Bloomberg, Wall Street Journal, until most people are aware of it.

This morning, on my drive between houses, I heard an interview with some guy who discussed the workings at the Federal Reserve's conducting of the stress tests. He said that the stress tests were based on a fixed of conditions of the 2000's banking crisis that aren't relevant to today's system or macroeconomics and the Fed has never bothered to update them to changing conditions.

This segment addressed the fact that it's not meaningful to criticize whether SVB was regulated well and should have been stress tested, etc, because the stress tests and the quality controls on banks that have been in place since the great financial crisis, wouldn't catch these problems anyways because they're outdated.

The stress tests are designed test recession conditions with low and falling interest rates. Right now we are realistically facing more of a disrupted trade period with a lot of supply side inflation (a post-pandemic/sanctions era/trade war period) with inflation that isn't necessarily driven by wage inflation but with the Fed hiking rates as if it were, and rate hikes are continuing, creating dislocations in investor and savings behavior.

That means that the stress tests that the Fed has been been using up to now, even while inflation was rising and some analysts were calling for "stagflation", aren't relevant to the banking environment that we are in, and the Fed knew or should have expected that the stress tests aren't meaningful, since 2021.

Basically, unless we're facing a recession with low and falling interest rates, these Fed's stress-tested banks might as well not have even been stress tested at all. I.e. we don't know what conditions the banks are in for our current macroeconomic environment. Basically, anything can happen as some of the quality controls that have been in place don't provide the controls they were supposed to.

That suggests to me two things:

1. We don't really know anything about how much stress or challenge our banks can take, for the current macro environment, i.e. we know less than the analysts who rate the banks and the stability of the financial system are supposed to assume they know when they factor in stress testing and other confidence measures.

2. The Fed might have to start dropping interest rates sooner rather than later, because the downside risks to a high interest rate regime have gone up a lot since the Fed has only been stress testing and managing bank controls as if low interest rates were a forever thing. This might force the Fed conform to its own lack of preparation, abandoning the pretense that it it is prepared to operate and manage bank system stability in a high interest rate environment.

tldr; The Fed's failure to prepare to regulate bank stability in anything but a low-interest rate environment has created a lot of downside risks for it continuing a high interest rate regime. For example, the Fed's stress tests are all still geared to testing banks stability in a low-and-falling interest rate recessionary environment that isn't meanginful in today's macro environment, so the stress tests that it's been using for vetting banks turns out to have been meaningless for predicting bank stability in 2023. The Fed has demonstrated it hasn't prepared for a high interest rate environment and that means it can't perform the function of anticipating and pre-emptively managing banking system instability, as it was supposed to be able to do. I feel the Fed's own failure to prepare to operate in a high interest rate environment increases the probability that the Fed will have to resort to dropping its interest rate hikes and starting to cut interest rates very soon, if current bank issues don't resolve very, very quickly.