Working Paper: CEPR ID: DP13907
Authors: Joel Shapiro; Jing Zeng
Abstract: Bank stress tests are a major form of regulatory oversight. Banks respond to the toughness of the tests by changing their lending behavior. Regulators care about bank lending; therefore, banks' reactions to the tests affect the tests' design and create a feedback loop. We demonstrate that stress tests may be (1) soft, in order to encourage lending in the future, or (2) tough, in order to deter excessive risk-taking in the future. There may be multiple equilibria due to strategic complementarity. Regulators may strategically delay stress tests. We also analyze bottom-up stress tests and banking supervision exams.
Keywords: Bank Regulation; Stress Tests; Bank Lending; Reputation
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Soft stress test (C54) | Increased lending by banks (G21) |
| Tough stress test (E44) | Decreased lending by banks (G21) |
| Tough stress test (E44) | Reduction in risky loans (G21) |