A recent abstract using empirical data, various methodologies and relevant news articles by De Nederlandsche Bank concludes that there is “only weak evidence that stress tests after 2009 affected equity returns of large US banks”.
Equity returns were only affected by the disclosure of the stress test results in 2012 and only for non-gap banks, according to their findings.
Stress tests are an important tool for banking supervisors. Thus, it’s important to consider their effects on stock and credit markets.
The Dutch bank’s abstract quantifies the market reactions of US stress tests performed after the start of the financial crisis by considering their effects on stock returns, CDS spreads, systematic risk, and systemic risk.
US stress tests considered are:
1) Supervisory Capital Assessment Program (SCAP) of the 19 largest Bank Holding Companies (BHCs).
2) Comprehensive Capital Analysis and Review (CCAR) program which assesses the capital planning processes and capital adequacy of banks.
3) Dodd-Frank Act Stress Test (DFAST) stems from the Dodd-Frank Act and requires assessing how bank capital levels would fare in stressful scenarios.
Preventing Crisis
The Federal Reserve stress tests are designed to prevent a repeat of the 2008 financial crisis, when the banking system teetered near collapse and the U.S. created a $700 billion taxpayer-funded bailout program. Firms in this year’s tests must describe what would happen to capital ratios, revenue and loss rates on various assets in dire scenarios described by the Fed.
Referring to post-crisis stress tests former Federal Reserve chairman Ben Bernanke stated last year:
“Even outside of a period of crisis, the disclosure of stress test results and assessments provides valuable information to market participants and the public, enhances transparency, and promotes market discipline.”
The Dutch working paper agrees.
“We have concluded that stress tests have produced valuable information for market participants and can play a role in mitigating bank opacity. Our findings indicate that post-crisis stress tests a ffected the CDS market strongly but had less impact on bank stock returns.”
The researchers add that their findings suggest that stress tests are a useful tool in mitigating risk in stock and credit markets.
Read the whole report here. Click below to download the “Banking Stress Test Effects on Returns and Risks” pdf:
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