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EBA Policy Research Workshop Summary: "How to Measure the Riskiness of Banks"

Core Content

The document presents a summary of the findings from the 3rd EBA Policy Research Workshop, focusing on the impact of banking stress tests on equity returns, credit risk, and systematic risk. The study analyzes the effects of stress test announcements, methodology disclosures, and result publications on large US banks between 2009 and 2013, using data from SCAP, CCAR, and DFAST.

Main Points and Key Findings

• Scope of Analysis: The research examines the market reactions to the announcement, methodology, and results of stress tests, particularly their impact on equity prices, credit spreads, and betas.
• Data and Timeframe: The study is based on US banking stress tests conducted from 2009 to 2013.
• Methodology: Event study methodology is applied to assess changes in the Capital Asset Ratio (CAR), credit spreads, and betas following stress test events.
• Key Results:
  • Equity Returns: After the publication of stress test results, equity returns of large US banks increased, but the results were mixed in terms of the sign and significance of the effect. SCAP (Stress Test for the US banking system) had the largest impact.
  • Credit Spreads (CDS): CDS spreads declined following the publication of results, but again, the results were mixed and not always significant.
  • Systemic Risk (Betas): There was a general decline in betas, indicating a reduction in systemic risk.

Policy Implications

• Market Perception: The study highlights the importance of understanding how markets perceive stress tests. The credibility and thoroughness of the process are positively viewed by analysts.
• Disclosure Extent: The extent of disclosure (including announcement, methodology, and results) is a critical factor in the effectiveness of stress tests. The article suggests that policymakers should consider the impact of these different disclosure stages.
• Transparency and Comparability: The stress tests are praised for significantly enhancing transparency and providing an unprecedented level of comparability across institutions.
• Feedback and Improvement: The authors recommend incorporating more detailed information in future stress test exercises, especially regarding the impact of specific events and the link between results and disclosure levels.

Example: Market Reactions to Stress Test Publication (26 October)

• Initial Reactions: The market showed calmness and limited volatility in bank equity prices and stable CDS spreads. Some isolated name-specific volatility was observed.
• Post-Publication Volatility: In the second week following the publication, the Euro Stoxx 600 banks saw a decline of approximately 2.99%. The 1-month change was around -0.6%.
• Analyst Assessments: Analysts generally regarded the stress test exercise as credible and thorough. They noted the similarity to US scenarios and praised the clarity on NPA recognition and loan loss coverage.
• Areas for Criticism: The study points out that some elements were missing, such as leverage ratio considerations, RWA harmonisation, capital floors on model usage, and TLAC (Total Loss Absorbing Capacity) requirements.

Comments and Potential Extensions

• Mixed Signals: The results show mixed signals, with SCAP having the most significant impact. The differing signs make it challenging to draw consistent policy conclusions.
• Need for More Context: Additional information on the SCAP event and other factors influencing the results would help in interpreting the findings more accurately.
• Clarifications Required: The article could benefit from more detailed explanations of definitions and data presented in tables to improve clarity for the reader.
• Further Research Opportunities: The study suggests that analyzing results based on different groups of banks, defined by their capitalisation levels before the stress test, could provide more nuanced insights.

Conclusion

The workshop highlights the importance of stress test disclosure in influencing market perceptions and reducing systemic risk. It underscores the need for further research and clarification in order to better understand the impact of stress tests and improve their design and implementation.