Stress testing programs and credit risk opacity of banks: USA vs Europe

Abstract

Regulators strengthened banking supervision in the aftermath of the Great Financial Crisis by stress testing banks intending to increase the amount of information available about the risks they face, improving their transparency and restoring market confidence. This study examines whether the results of stress tests conducted between 2009 and 2019 in the US and the EU have reduced the opacity of information about banks' credit risk. We study changes in banking sector opacity around the disclosure of stress test results in a panel data framework. We measure opacity by discrepancies in bank credit ratings issued by different agencies. The findings indicate a lower opacity level after disclosing the US test results. The most significant reduction occurs for systemic banks with higher leverage that fail the test. The European testing programme has specific disclosure features that could justify that the effect of disclosure of stress test results is more attenuated for EU banks. Some indirect evidence suggests that differences in stress test programmes and banking sector structure between the two regions may explain the result.