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Harvard professor: Bank stress tests won’t save us from financial crisis

It’s a big week for Wall Street. Minutes before polls close in the U.K. on the Brexit vote Thursday, the Fed is set to release its first round of stress-test results, followed by a second round of results next Wednesday. The tests are used to determine whether or not the largest banks could weather a major crisis, such as Britain leaving the EU, and whether they can boost their dividend payout to shareholders.

Hal Scott, Harvard professor and author of the new book “Connectedness and Contagion,” told Yahoo Finance’s Seana Smith that bank stress tests are not enough to avert financial crises, and that contagion acts as a bigger threat than "too big to fail.”

“After the 2008 crisis we greatly increased bank capital. That’s good; it’s now around 15% of equity for the largest banks,” said Scott. “But in a financial panic, 15% of capital is nowhere near enough to withstand the effect of a run on a financial system. Unlike 2008, where the Fed had very strong powers, to help stop a contagious run, we’re much less able to deal with that now because those powers have been restricted.”

The issue of whether banks had enough capital to withstand a crisis came to the light earlier this year, when the Federal Reserve and FDIC rejected the “living wills” of Bank of America (BAC), JPMorgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFC) and State Street.

In terms of which bank is under the most pressure in regards to this week’s stress test, Scott says there’s no particular bank that’s feeling the heat. Instead, it’s "a system wide issue if there is a problem at all."

The Fed is assessing 33 institutions this year, two more than last year. The tests will be on both U.S.-based banks and the U.S. units of big global banks.