Working Paper: CEPR ID: DP12624
Authors: Friederike Niepmann; Viktors Stebunovs
Abstract: We investigate systematic changes in banks’ projected credit losses between the 2014and 2016 EBA stress tests, employing methodology from Philippon et al. (2017). Wefind that projected credit losses were smoothed across the tests through systematic modeladjustments. Those banks whose losses would have increased the most from 2014 to2016 due to changes in the supervisory scenarios—keeping the modelsconstant—saw the largest decrease in losses due to model changes. Model changes were more pronounced for banks that rely more on the Internal Ratings-Basedapproach, and they explain the cross-section of market responses to the release of the 2016results. Stock prices and CDS spreads increased more for banks with larger reductionsin projected credit losses due to model changes, as investors apparently did not interpretlower loan losses as reflecting mainly a decrease in credit risk but, instead, as a sign of lowercapital requirements going forward.
Keywords: stress tests; financial institutions; regulation; credit risk; models
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroeconomic variables (E19) | banks' projected loan loss rates (G21) |
| changes in banks' risk weight densities (G21) | banks' projected loan loss rates (G21) |
| model adjustments (C51) | banks' projected credit losses (G21) |
| supervisory scenarios (E17) | banks' projected credit losses (G21) |
| model changes (C52) | stock prices (G12) |
| model changes (C52) | credit default swap (CDS) spreads (G12) |
| reductions in projected losses (G52) | investor interpretation of lower capital requirements (G31) |