The Effects of the Stress-Testing Exercises on Banks’ Lending, Profitability and Risk-Taking: Are There Unintended Side Effects?

The Effects of the Stress-Testing Exercises on Banks’ Lending, Profitability and Risk-Taking: Are There Unintended Side Effects?

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.

Giuseppe Cappelletti, Cecilia Melo Fernandes, and Aurea Ponte Marques

SSRN

October 30, 2019

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By |2019-12-03T07:52:27-08:00January 1st, 2018|Capital Requirements, Financial Regulation, Reference|