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Bank Regulator Bias and the Efficacy of Stress Test Disclosures

48 Pages Posted: 3 Jul 2015 Last revised: 20 Oct 2015

Andrew Bird

Carnegie Mellon University - Tepper School of Business

Stephen A. Karolyi

Carnegie Mellon University - Tepper School of Business

Thomas G. Ruchti

Carnegie Mellon University - Tepper School of Business

Austin C. Sudbury

Carnegie Mellon University - Tepper School of Business

Date Written: October 19, 2015

Abstract

We examine the Federal Reserve's (the Fed) propensity to bias reported stress test results in the Comprehensive Capital Analysis and Review (CCAR). Using capital market responses to the CCAR, we develop and estimate a model of biased disclosure that incorporates a regulator's trade-off between disciplining banks and promoting short-term stability. We find the Fed biases disclosed capital ratios upwards to prop up large banks, but downwards to discipline poorly capitalized banks. These biases have real effects on bank behavior — propped-up banks are less likely to subsequently improve their capital ratios by raising equity or cutting dividends.

Keywords: regulatory disclosure, bias, CCAR, financial institutions, stability, SCAP

Suggested Citation

Bird, Andrew and Karolyi, Stephen A. and Ruchti, Thomas G. and Sudbury, Austin C., Bank Regulator Bias and the Efficacy of Stress Test Disclosures (October 19, 2015). Available at SSRN: https://ssrn.com/abstract=2626058 or http://dx.doi.org/10.2139/ssrn.2626058

Andrew Bird

Carnegie Mellon University - Tepper School of Business ( email )

Pittsburgh, PA 15213-3890
United States

Stephen A. Karolyi

Carnegie Mellon University - Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
4122682909 (Phone)

Thomas G. Ruchti (Contact Author)

Carnegie Mellon University - Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Austin C. Sudbury

Carnegie Mellon University - Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

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