Stressed Banks? Evidence from the Largest-Ever Supervisory Review

Abstract

Regulation needs effective supervision; but regulated entities may deviate with unobserved actions. For identification, we analyze banks, exploiting the European Central Bank’s asset-quality-review (AQR) and supervisory security and credit registers. After the announcement of the AQR, reviewed banks reduce riskier securities and credit (also overall securities and credit supply), with the largest impact on riskiest securities (rather than riskiest credit), and with immediate negative spillovers on asset prices and firm-level credit supply. Exposed (unregulated) nonbanks buy the risk that reviewed banks shed. The AQR drives the results, not end-of-year effects. After the AQR compliance, reviewed banks reload riskier securities, but not riskier credit, with medium-term negative firm-level real effects (costs of supervision/safe-assets increase).

Keywords: Asset quality review, stress tests, supervision, risk-masking, costs of safe assets

JEL Classification: E58, G21, G28, H63, L51