DP16157 The disciplining effect of supervisory scrutiny in the EU-wide stress test

Author(s): Christoffer Kok, Carola Müller, Steven Ongena, Cosimo Pancaro
Publication Date: May 2021
Keyword(s): banking regulation, Banking Supervision, credit risk, Internal Models, Stress Testing
JEL(s): G11
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16157

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.