The Coordination Role of Stress Tests in Bank Risk‐Taking

Journal of Accounting Research, Volume 57, Issue 5, December 2019

Posted: 9 Mar 2020

See all articles by Carlos Corona

Carlos Corona

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Lin Nan

Purdue University

Gaoqing Zhang

University of Minnesota

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2019

Abstract

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

Corona, Carlos and Nan, Lin and Zhang, Gaoqing, The Coordination Role of Stress Tests in Bank Risk‐Taking (December 1, 2019). Journal of Accounting Research, Volume 57, Issue 5, December 2019, Available at SSRN: https://ssrn.com/abstract=3538445

Carlos Corona

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

HOME PAGE: http://https://fisher.osu.edu/people/corona.55

Lin Nan

Purdue University ( email )

100 S Grant St
West Lafayette, IN 47907
United States
7654960551 (Phone)

Gaoqing Zhang (Contact Author)

University of Minnesota ( email )

321 19th Avenue South
Minneapolis, MN 55455
United States

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