Bank Regulator Bias and the Efficacy of Stress Test Disclosures
48 Pages Posted: 3 Jul 2015 Last revised: 20 Oct 2015
Date Written: October 19, 2015
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
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