The Coordination Role of Stress Tests in Bank Risk‐Taking
Journal of Accounting Research, Volume 57, Issue 5, December 2019
Posted: 9 Mar 2020
Date Written: December 1, 2019
We examine whether stress tests distort banks' risk‐taking decisions. We study a model in which a regulator may choose to rescue banks in the event of concurrent bank failures. Our analysis reveals a novel coordination role of stress tests. Disclosure of stress‐test results informs banks of the failure likelihood of other banks, which can reduce welfare by facilitating banks' coordination in risk‐taking. However, conducting stress tests also enables the regulator to more effectively intervene banks, coordinating them preemptively into taking lower risks. We find that, if the regulator has a strong incentive to bail out, stress tests improve welfare, whereas if the regulator's incentive to bail out is weak, stress tests impair welfare.
Keywords: stress test; stress-test disclosure; bank regulation; bank risk-taking; bailout; coordination
JEL Classification: G01; G21; G28; M40; M41
Suggested Citation: Suggested Citation