The Effects of the Stress-Testing Exercises on Banks’ Lending, Profitability and Risk-Taking: Are There Unintended Side Effects?
27 Pages Posted: 11 Nov 2019
Date Written: October 30, 2019
This research aims to investigate whether the stress-testing exercises affect credit supply, banks’ profitability and risk-taking behaviour. The granular confidential supervisory data of Euro Area banks allows for a quasi-natural experiment to identify this impact with a difference-in-differences matching estimator. We find that, as a consequence of the 2016 stress-testing exercises, treated banks increase their capital ratios by reducing their lending and risk-taking to households and non-financial corporates, implying a decrease in banks' profitability. Results support the hypothesis that the implementation of the stress-testing framework could have a positive disciplining effect by reducing banks' risk-taking while having also an adverse impact on the real economy through a temporary decrease in credit supply and profitability. Results are stable for different specifications and were validated by the parallel trend test and a supplementary regression approach. In addition, we provide an analysis focused on stress-testing results publicly available (versus not available), suggesting that the disclosure of the stress test results reinforces the supervisory and market discipline.
Keywords: Stress-Tests, Bank Capital-Based Measures, Bank Risk-Shifting, Profitability, Credit Supply
JEL Classification: E44, E51, E58, G21, G28
Suggested Citation: Suggested Citation