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

See all articles by Giuseppe Cappelletti

Giuseppe Cappelletti

European Central Bank (ECB)

Cecilia Melo Fernandes

European Insurance and Occupational Pensions Authority

Aurea Ponte Marques

European Central Bank (ECB)

Date Written: October 30, 2019

Abstract

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

Cappelletti, Giuseppe and Melo Fernandes, Cecilia and Ponte Marques, Aurea, The Effects of the Stress-Testing Exercises on Banks’ Lending, Profitability and Risk-Taking: Are There Unintended Side Effects? (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=3478913 or http://dx.doi.org/10.2139/ssrn.3478913

Giuseppe Cappelletti

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Cecilia Melo Fernandes (Contact Author)

European Insurance and Occupational Pensions Authority ( email )

Westhafenplatz 1
Frankfurt am Main, 60327
Germany

Aurea Ponte Marques

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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