Are Stress Tests Beauty Contests?

EBA Staff Papers (2019)

15 Pages Posted: 31 Jul 2019

Date Written: July 22, 2019

Abstract

There is increasing debate on whether official-sector stress tests are fit for purpose and deliver what they are designed for. In the EU, this discussion focuses on the costs and benefits of such a large-scale bottom-up exercise and on the possible options to improve its usefulness for banks, supervisors and the general public, but also on exploring ways to make it less burdensome.

This paper discusses whether some improvements to the design of the EU-wide stress test could better align the incentives of the different stakeholders involved. In particular, the objective is to understand whether there is room for mitigating the beauty contest problem, namely the problem that banks are more interested in showing that they are outperforming others than in identifying actual risks in an adverse scenario.

Keywords: Stress test, bank, EBA, supervision, beauty contest, incentives

JEL Classification: G18, G21

Suggested Citation

Quagliariello, Mario, Are Stress Tests Beauty Contests? (July 22, 2019). EBA Staff Papers (2019). Available at SSRN: https://ssrn.com/abstract=3427389 or http://dx.doi.org/10.2139/ssrn.3427389

Mario Quagliariello (Contact Author)

European Banking Authority ( email )

Floor 46
One Canada Square, Canary Wharf
London, E14 5AA
United Kingdom

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