DP12624 Modeling Your Stress Away
We investigate systematic changes in banks’ projected credit losses between the 2014
and 2016 EBA stress tests, employing methodology from Philippon et al. (2017). We
find that projected credit losses were smoothed across the tests through systematic model
adjustments. Those banks whose losses would have increased the most from 2014 to
2016 due to changes in the supervisory scenarios—keeping the models
constant—saw the largest decrease in losses due to model changes. Model changes were more pronounced for banks that rely more on the Internal Ratings-Based
approach, and they explain the cross-section of market responses to the release of the 2016
results. Stock prices and CDS spreads increased more for banks with larger reductions
in projected credit losses due to model changes, as investors apparently did not interpret
lower loan losses as reflecting mainly a decrease in credit risk but, instead, as a sign of lower
capital requirements going forward.
