The effects of supervisory stress testing on bank lending: examining large UK banks

Abstract

In this paper, we study the effects of supervisory stress test exercises on 19 UK banks over the 2005–2018 period. The novelty of our approach is that we include two stress testing timelines from two banking supervisory authorities. Using a difference-in-difference methodology, in a first step, we analyse the effects of the Bank of England’s stress tests on the lending behaviour of large UK banks. In a second step, for robustness, we also examine the stress tests administered by the European Banking Authority. Our main result is that banks that failed the stress tests reduced lending. Additionally, we show that the effectiveness of the stress tests exercises remained unchanged throughout the period.