Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/281999 
Year of Publication: 
2024
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 3/2024
Publisher: 
Bank of Finland, Helsinki
Abstract: 
We study a competitive banking sector in which banks choose the level of risk of their asset portfolios and, upon the public disclosure of stress test results, raise funding by promising investors a repayment. We show that competition forces banks to choose risky assets so as to promise investors high repayments, and to gamble on favorable stress test results. Increasing stress test precision increases banks' asset riskiness but also improves allocative efficiency. When risk taking is not too sensitive to the precision of information, maximal transparency maximizes both stability and surplus. In contrast, when banks exercise market power assets are less risky, while opacity maximizes banks' stability and, when the social cost of bank failure is sufficiently large, the surplus as well. Our results in overall highlight the need to take into account the structure of banking industry when designing stress tests.
Subjects: 
financial stability
stress tests
bank transparency
banking regulation
bank competition
JEL: 
G21
G28
D83
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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