Working Paper

Stressed Banks? Evidence from the Largest-Ever Supervisory Review

Abstract: We study short-term and medium-term changes in bank risk-taking as a result of supervision, and the associated real effects. For identification, we exploit the European Central Bank's asset-quality review (AQR) in conjunction with security and credit registers. After the AQR announcement, reviewed banks reduce riskier securities and credit supply, with the greatest effect on riskiest securities. We find negative spillovers on asset prices and firm-level credit availability. Moreover, non-banks with higher exposure to reviewed banks acquire the shed risk. After the AQR compliance, reviewed banks reload riskier securities but not riskier credit, resulting in negative medium-term firm-level real effects. These effects are especially strong for firms with high ex-ante credit risk. Among these non-safe firms, even those with high ex-ante productivity experience negative real effects. Our findings suggest that banks' liquid assets help them to mask risk from supervisors and risk adjustments banks make in response to supervision have persistent corporate real effects.

Keywords: Corporate real effects from bank credit; Asset quality review; Stress tests; Supervision; Risk-masking; Costs of safe assets;

JEL Classification: E58; G21; G28; H63; L51;

https://doi.org/10.17016/FEDS.2023.021

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2023-04-13

Number: 2023-021