Stress Testing and Bank Lending
64 Pages Posted: 8 Aug 2019
Date Written: August 5, 2019
Bank stress tests are a major form of regulatory oversight. Banks respond to the toughness of the tests by changing their lending behavior. Regulators care about bank lending; therefore, banks' reactions to the tests affect the tests' design and create a feedback loop. We demonstrate that stress tests may be (1) soft, in order to encourage lending in the future, or (2) tough, in order to deter excessive risk-taking in the future. There may be multiple equilibria due to strategic complementarity. Regulators may strategically delay stress tests. We also analyze bottom-up stress tests and banking supervision exams.
Keywords: Bank regulation, stress tests, bank lending, reputation
JEL Classification: G21, G28
Suggested Citation: Suggested Citation