Stress Testing and Bank Lending
62 Pages Posted: 8 Aug 2019 Last revised: 18 Jun 2020
Date Written: June 18, 2020
Stress tests can affect banks' lending behavior. Since regulators care about lending, banks' reactions affect the test's design and create a feedback loop. We demonstrate that there may be multiple equilibria due to strategic complementarity, possibly leading to excess default or insufficient lending to the real economy. The stress tests may be too soft or too tough. Banking supervision exams have similar properties. When the recapitalization of banks becomes more difficult, stress tests are less informative. However, when a bank is more systemic, the stress test will be more informative.
Keywords: Bank regulation, stress tests, bank lending, feedback effect
JEL Classification: G21, G28
Suggested Citation: Suggested Citation