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Carola Müller

29 October 2019
MACROPRUDENTIAL BULLETIN - ARTICLE - No. 9
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Abstract
This article aims to contribute to the ongoing discussion about the long-term strategy for stress testing in the euro area. In particular, it highlights some of the strengths and weaknesses of the constrained bottom-up approach, which is currently used in the EU‑wide stress-testing exercise. Under this approach, banks use their own models to generate stress test projections on the basis of a common macroeconomic scenario and under the constraints imposed by the European Banking Authority methodology. This set-up provides banks with some scope to underestimate their vulnerabilities in order to appear more resilient than their peers. This article confirms previous empirical evidence showing that such behaviour may indeed be practised by banks. This, in turn, requires a robust quality assurance of banks’ stress test projections by the competent authorities (including the European Central Bank), to enforce more realistic results. Against this background, the article presents a novel empirical analysis providing indicative evidence that the “supervisory scrutiny” relating to the quality assurance may be having a disciplining effect on banks’ risk-taking.
JEL Code
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
14 May 2021
WORKING PAPER SERIES - No. 2551
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Abstract
Using a difference-in-differences approach and relying on confidential supervisory data and an unique proprietary data set available at the European Central Bank related to the 2016 EU-wide stress test, this paper presents novel empirical evidence that supervisory scrutiny associated to stress testing has a disciplining effect on bank risk. We find that banks that participated in the 2016 EU-wide stress test subsequently reduced their credit risk relative to banks that were not part of this exercise. Relying on new metrics for supervisory scrutiny that measure the quantity, potential impact, and duration of interactions between banks and supervisors during the stress test, we find that the disciplining effect is stronger for banks subject to more intrusive supervisory scrutiny during the exercise.
JEL Code
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation