Bank Stress Testing: Public Interest or Regulatory Capture?
We test whether measures of potential influence on regulators affect stress test outcomes. The large trading banks – those most plausibly ‘Too big to Fail’ – face the toughest tests. In contrast, we find no evidence that either political or regulatory connections affect the tests. Stress tests have a greater effect on the value of large trading banks’ portfolios; the large trading banks respond by making more conservative capital plans; and, despite their more conservative capital plans, the large trading banks still fail their tests more frequently than other banks. These results are consistent with a public-interest view of regulation, not regulatory capture.
We thank seminar participants at the Columbia University, the Federal Reserve Bank of New York, and Kellogg. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Philip E. Strahan
Strahan has visited the Federal Reserve Bank of New York on many occasions over the past 10 years as a research consultant. In addition, he served for three years on the Federal Reserve's Model Validation Council, which provides input into the U.S. stress testing regime.