The disciplinary effect of banking supervision: is the EU-wide 2023 stress test merely a supervisory formality?

This study presents empirical findings showing that supervisory oversight, particularly within the framework of stress testing, serves as a catalyst in reducing bank opacity and risk. Unlike previous research that primarily examines how market participants react to the disclosure of stress test results, our study shifts the focus to the internal decision-making processes of participating banks. Our analysis indicates that banks involved in the 2023 EU-wide stress test experienced a decline in credit risk in the subsequent quarters, although this effect diminished over time. Specifically, the findings provide insight into the a posteriori impact of supervisory oversight on banks’ risk profiles. This study substantiates the role of banking supervision – within the context of solvency stress tests – by demonstrating to investors, supervisors, and other stakeholders that stronger supervisory oversight has a more pronounced disciplinary influence on banks’ risk-taking behavior, while potentially creating strategic optionality. Ultimately, our study carries important implications for the ongoing discussions on simplifying banking supervision.