Large Scale Supervisory Assessment Of Banks: Where Is The Beef?

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Large Scale Supervisory Assessment Of Banks: Where Is The Beef?

Valter Lazzari

LIUC Università Cattaneo; SDA Bocconi School of Management

Andrea Venegoni

LIUC Università Cattaneo

Luigi Vena

LIUC Università Cattaneo

January 7, 2016


In banking supervision it has become common practice to perform a simultaneous standardized assessment of all regulated banks in terms of asset quality, organizational effectiveness, strategic viability and resilience to financial turmoil, as well as to disclose such findings. By investigating the ECB 2014 Comprehensive Assessment and the subsequent banks’ stock price reaction we find that, despite the regulator’s declared intention, this type of exercise provides limited informational support to the market in sorting good from bad banks. In spite of it, the market values the news conveyed by the announcement of these findings, as they signal the stance of the supervisory policy with respect to the banks activities which will be subject to a harsher and more costly supervision.

Large Scale Supervisory Assessment Of Banks: Where Is The Beef? – Introduction

In the aftermath of the big financial crisis of 2008, banking authorities worldwide realized that their traditional approach to regulation and supervision had failed to detect and mitigate possibly fatal weaknesses of the banking system such as a widespread undercapitalization, an excessive level and concentration of risk exposures, unsafeguarded pervasive interconnections among banks. In the ensuing quest for new supervisory practices, authorities innovated their tools to become more effective in detecting the underlying risk of regulated banks while ensuring the cost efficiency required to implement these practices regularly on a large number of banks.

Abstracting from the operational practices which differ between the US and Europe, the pillars of this new approach to supervision are the same. For each bank, authorities assess and disclose the quality of its assets, the viability of its business and organizational model and its resilience to a future economic turmoil, as defined by a properly designed stress test. Results of the assessment feedback in the supervisory decision about each bank’s capital requirement.

An exercise which includes all three types of assessment is qualified as “comprehensive”. A Comprehensive Capital Analysis and Review Process is now run yearly in the US and a Comprehensive Assessment (CA) was performed by the European Central Bank (ECB) in 2014. So far there is scant evidence on the effectiveness of these newly adopted supervisory practices. Literature is scarce and provides contradicting indications. Morgan et al. (2014) find that the exercise run by the Federal Reserve in 2009 contributed to restart the U.S. economy. Schuermann (2014) and Steffen (2014) doubt the effectiveness of the European Banking Authority (EBA) approach in unveiling the banks’ resilience to economic shocks and in fostering their transparency. Ellahie (2012) finds that the two stress tests run on the major European banks in 2010 and 2011 did not provide a valuable contribution in terms of information disclosure, leaving the market sceptical of the ability of such exercises to unveil the financial health of banks. Sahin and De Haan (2015) arrive to the same conclusion with respect to the CA, as they detect only a feeble market reaction of stock and CDS prices to the announcement of the CA results. Petrella and Resti (2012) find instead that the 2011 European Stress Test disclosed relevant information on banks’ exposures and on their resilience to downturns.

Such exercises have been subject to intensive criticism in the public policy arena. In the U.S, the 2009 assessment was a success and the concerns on the effect of the disclosure of its results proved to be ill founded (Bernanke 2010). In Europe, it was felt the risk that a flawed design or execution of the assessments might have skewed the playing field and prevented the ECB from reaching its goal: to identify the problem assets and clean the banks’ balance sheets (Steffen, 2014).

We aim to provide some new insights in the strand of literature on the effectiveness of these recent supervisory practices, contributing novel evidence on the 2014 ECB’s CA and clarifying some of the related hotly debated policy issues.

Large Scale Supervisory Assessment Of Banks

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