Assessing the financial and informational role of supervisory stress tests: EU-wide 2018 stress test vis-à-vis EU-wide 2021 stress test
| Date | 03 February 2023 |
| Pages | 397-419 |
| DOI | https://doi.org/10.1108/JFRC-06-2022-0075 |
| Published date | 03 February 2023 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Dimitrios Karakostas,Ioannis Tsakalos,Athanasios Fassas |
Assessing the financial and
informational role of supervisory
stress tests: EU-wide 2018
stress test vis-
a-vis EU-wide
2021 stress test
Dimitrios Karakostas,Ioannis Tsakalos and Athanasios Fassas
Department of Accounting and Finance, University of Thessaly, Larissa, Greece
Abstract
Purpose –The supervisory stress test evaluates the capital adequacy and profit-generation capacity of
systemic banking institutions under baseline and adverse macroeconomic scenarios. This study aims to
assess the financial and informational role of European stress tests and substantiate the impact of their
disclosures by examiningthe EU-wide 2018 stress test vis-
a-vis the EU-wide 2021 stress testin terms of how
and to what extentthe stock prices of the stress-tested banks have beenaffected.
Design/methodology/approach –This study applies standard event studymethodologies to evaluate
the reactions of market participants during the EU-wide 2018 and 2021 stress test exercises. We examine
several“large”events in both the exercises for a selectedsample of European banks.
Findings –The results of our eventstudy analysis show that the EU-wide 2018 and 2021 stresstests come
subsequent to considerable abnormal price movements. The announcement of stress test results triggered
tangible investor reactions,indicating the informational value of stress tests inreducing bank opacity. This
supervisory“toolkit”is considered extremely important, as it providesmeaningful insights to the supervisors
of the banking institutionsand the market stakeholders by improving the transparencyof the financial sector,
allowingthem to segregate banks more effectively.
Originality/value –This study constitutes one of the earliestattempts to shed light on the financial and
information role of the Europeansupervisory stress tests by comparing the EU-wide 2018 andthe EU-wide
2021 stress test exercises. Moreover, it provides concrete empirical evidence and qualitative analysis to
explorecertain aspects of the European and US stress tests.
Keywords Stress tests, Event study analysis, Bank opacity, Regulatory disclosures
Paper type Research paper
1. Introduction
Stress tests play a crucial role in banking supervision because they assess how banks can
deal with financial and economic shocks, as well as uncover the vulnerabilities of the
banking sector. Considering the recent financial crisis, supervisory authorities worldwide
have started using the stress testing“toolkit”more regularly than in the past in an attempt
to promote and uphold confidence among banking stakeholders. This practice not only
increases the resilience of the banking sectorthrough mandatory capital increases but also
enhances the transparency of the banking community, allowing investors to better
differentiate betweenthe “good”and “bad”banks (Georgescu et al., 2017).
The asymmetric information between the banks and the investment community may
become noticeable during a financial crisis, which is more likely to trigger an adverse
selection bias among financial institutions. In that case, the “good”banks will suffer a
Supervisory
stress tests
397
Received11 June 2022
Revised4 November 2022
Accepted4 January 2023
Journalof Financial Regulation
andCompliance
Vol.31 No. 4, 2023
pp. 397-419
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-06-2022-0075
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
competitive disadvantage becausethe investors may not distinguish between them and the
“bad”(i.e. unhealthy) banks. Thus, the stress tests will help disclose the previously
unidentified risks and provide comfort to allay the fearsof the investors and force banking
institutions to restore their capitaladequacy ratios. Therefore, stress tests provide valuable
information to the bankingsector and support overall financial stability (Morganet al.,2014;
Georgoutsos and Moratis,2020).
This study aims to assess the informational value of stress tests and illuminate the
potential impact of their disclosures. Our analysisevaluates the market reaction concerning
the EU-wide 2018 stress test vis-
a-vis the EU-wide 2021 stress test and assesses the
implications of “large”events during that period on share price return reactions.
Specifically, our study attemptsto illuminate the following aspects of the supervisory stress
test, which are considered “large”eventsthroughout our analysis:
Q1. How did the publication of the European Banking Authority (EBA) methodology
for stress testing affectthe share prices of the participating banks?
Q2. What implications did the release of macroeconomic scenario variables have on the
share prices of the EBA sample ofbanks?
Q3. To what extent did the announcement of the stress test results affect the share
prices?
The contribution of this study to the existingliterature is based on the quantitative analysis
and comparison among the EU-wide stress test and US stress tests, and their interrelation
for the market stakeholders, the assessment of the informational content of supervisory
stress test public disclosures in mitigating bank opacity, and the empirical evidencefor the
market reaction toward the EU-wide 2018 and 2021 stress test exercises. Our analysis
provides valuable insights for several reasons. First, we extend the literature on stress
testing, revealing key aspects of the supervisory stress test in Europe, considering the
literature on US stress tests. Second, we provide valuable information to investors,
supervisors and other public stakeholders for the EU-wide 2018 and 2021 stress test
exercises with regard to market discipline and information asymmetry. Third, we evaluate
the macroeconomic environment of each supervisory exercise, highlighting the headwinds
of the COVID-19 pandemic to provide meaningfulexplanations for the market reaction.
The results show a mean impact of the disclosure of the EU-wide stresstest results on the
equity returns of our sample, which reflects the fundamental role of supervisory stress
testing in the European markets’reaction. Our findings show mixed effects in the market
reaction of individual stress-tested banks across various European countries within
different “large”events. Nevertheless, the stress-testing toolkit appeared to have a different
magnitude in terms of cumulative abnormal and average cumulative abnormal returns
(CARs) for each supervisoryexercise and across the examined event dates.
The remainder of this study is structured as follows. Specifically, Section 2 reviews the
key aspects of the existing literature, whereas Section 3 presents the data used and the
methodology followed to investigatethe effect of the EU-wide 2018 and 2021 stress tests on
the stock price of our selected sample. Finally, Section 4 outlines the results of this study,
Section 5 presents the conclusions.
2. Literature review
Previous research on the implications of the Europeansupervisory stress test disclosures is
limited but emerging. The existing literature is mainly concentrated on the US stress test
JFRC
31,4
398
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