Supervisors as Information Producers: Do Stress Tests Reduce Bank Opaqueness?

Abstract

Supervisory stress tests assess the impact of an adverse macroeconomic scenario on the profitability and capitalisation of a large number of banks. The results of such stress test exercises have recently been disclosed to the public in an attempt to restore confidence and to curb bank opaqueness by helping investors distinguish between sound and fragile institutions. In an unprecedented effort for transparency, the 2011 European Union stress test lead to the release of some 3,400 data points for each of the 90 participating banks. This makes it an ideal setting to investigate a number of hypotheses on the information role of the stress tests.

In this paper we examine the 2011 European stress test exercise to assess whether and how it affected bank stock prices. Our event study analysis shows that the test’s results were considered relevant by investors. The market did not simply look at the detailed historical data which was released after the tests, but also attached considerable importance to variables measuring each bank’s vulnerability to the simulated downturn scenario. The latter include proxies for liquidity risk and model risk. Information on sovereign debt holdings, while affecting market reaction on a univariate basis, is not statistically significant in a multivariate setting.

We also find that the market is not able to anticipate the test results and this is consistent with the idea of greater bank opaqueness prior to the disclosure of the stress test results. Overall, our analysis shows that stress tests produce valuable information for market participants and can play a role in mitigating bank opacity.

Keywords: stress tests, financial crises, event study

JEL Classification: G01, G21, G14