Research Items (6)
Stress tests have been increasingly used in recent years by regulators to foster confidence in the banking sector by not only increasing its resilience via mandatory capital increases but also by enhancing transparency to allow investors to better discriminate between banks. In this study, using an event study approach, we explore how market participants reacted to the 2014 Comprehensive Assessment and the 2016 EBA EU- wide stress test. The results show that stress test disclosures revealed new information that was priced by the markets. We also provide evidence that the publication of stress test results enhanced price discrimination as the impact on bank CDS spreads and equity prices tended to be stronger for the weaker performing banks in the stress test. Finally, we provide some evidence that also sovereign funding costs were a�ected in the aftermath of the stress test publications. The results provide insights into the e�ects and usefulness of stress test-related disclosures.
The Global Crisis and its aftermath led to greater use of stress tests and to the establishment of macroprudential policy as a new policy area. In this eBook ECB staff presents new suite of analytical tools that support the design and calibration of macroprudential policy. The tools go well beyond the requirements of the traditional solvency stress tests applied to banks, and include a broader set of institutions than just banks, an analysis of the financial cycle, as well as an assessment of systemic risk levels associated with the economic and financial shocks considered in adverse scenarios.
This paper compares the contagion potential of mark-to-market accounting rules interacting with regulatory constraints to that of funding constraints in a network of banks. The fair value accounting rules were amended at the height of the crisis to break the vicious link between allegedly irrational market prices and regulatory constraints. Anecdotal evidence from the recent crisis suggests that funding constraints posed more serious problems to banks than regulatory constraints. Simulations results show that, for high levels of short-term debt relative to liquid asset holdings, the contagion potential arising due to funding constraints is higher than the one due to accounting induced regulatory constraints. Allowing balance sheet valuation to affect the expectations about future insolvency, and implicitly, the roll-over decision of short-term creditors, can amplify systemic risk relative to the case when only regulatory constraints are at play. The results could be interesting for a regulator wishing to achieve a trade-off between transparency, the main goal of fair value accounting, and financial stability.
We investigate three prominent German bank failures in the financial crisis of 2007-2008, Deutsche Industriebank AG (IKB), Landesbank Sachsen Girozentrale (Sachsen LB), and Hypo Real Estate Holding AG (HRE), to analyze the interrelation between financial reporting and financial stability. We make several interesting observations. Importantly, all three banks were regulated based on German local GAAP (HGB), not International Financial Reporting Standards (IFRS). Thus, some of the most spectacular failures of European banks occurred for banks that were regulated based on historical cost accounting. These banks took on very high leverage either on-balance sheet (HRE) or off-balance sheet (IKB and Sachsen LB). The evidence is important to guide the current regulatory debate as it challenges “conventional wisdom” on the relation between financial reporting, financial regulation, and financial stability, which is prominently used in this debate.
Applied to the European markets, this paper analyzes the price of credit risk on the Credit Default Swap (CDS) and corporate bond markets by comparing the sensitivity of the credit spreads on each market to systematic, idiosyncratic risk factors and liquidity. Our analysis confirms the existence of a long-run relationship between the two markets, and the tendency for CDS markets to lead corporate bond markets in terms of price discovery. We find that the outbreak of the financial turmoil in the summer of 2007 induced a substantial increase in risk aversion and a shift in the pricing of credit risk, with CDS markets becoming more sensitive to systematic risk while cash bond markets priced in more information about liquidity and idiosyncratic risk. Moreover, the financial turbulence also brought about a systematic disconnection between the two markets caused by the significant change in the lead-lag relationship, with CDS markets always leading the cash bond markets. JEL Classification: G12, G14, G15.