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The Coordination Role of Stress Tests in Bank Risk‐Taking

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  • CARLOS CORONA
  • LIN NAN
  • GAOQING ZHANG

Abstract

We examine whether stress tests distort banks' risk‐taking decisions. We study a model in which a regulator may choose to rescue banks in the event of concurrent bank failures. Our analysis reveals a novel coordination role of stress tests. Disclosure of stress‐test results informs banks of the failure likelihood of other banks, which can reduce welfare by facilitating banks' coordination in risk‐taking. However, conducting stress tests also enables the regulator to more effectively intervene banks, coordinating them preemptively into taking lower risks. We find that, if the regulator has a strong incentive to bail out, stress tests improve welfare, whereas if the regulator's incentive to bail out is weak, stress tests impair welfare.

Suggested Citation

  • Carlos Corona & Lin Nan & Gaoqing Zhang, 2019. "The Coordination Role of Stress Tests in Bank Risk‐Taking," Journal of Accounting Research, Wiley Blackwell, vol. 57(5), pages 1161-1200, December.
    • Handle: RePEc:bla:joares:v:57:y:2019:i:5:p:1161-1200
    DOI: 10.1111/1475-679X.12288
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    1. Tirupam Goel & Isha Agarwal, 2021. "Limits of stress-test based bank regulation," BIS Working Papers 953, Bank for International Settlements.

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