A Capstone paper by Venetia Woo, Wilfrid Xoual, and Bharat Chelluboina of the MS in Risk Management Class of 2013 was published by Financial Markets, Institutions and Instruments – NYU Salomon Center.
The Effectiveness of the Regulatory Stress Testing Disclosure Process
Following the biggest financial crisis since the Great Depression in the 1930s,
regulators around the world, pressured by politicians and public outcry, have
seriously promoted the usage of stress tests in adverse economic context to evaluate
how financial institutions would resists to such shocks.
System wide, Supervisory and Reverse Stress Tests are now exercises that
banks around the word have to undergo on a regular basis. This was to be expected,
but regulators seem to favor a new approach for the past couple of years: DISCLOSURE.
This paper argues that an effective disclosure of stress test results can contribute
to reduced systemic risk via improved market discipline, especially when markets
are in need of reassurance. Improvements can arise from a well-designed test,
clear communications regarding the purpose of the stress test and disclosure, and
from clarity regarding the limitations of the test. Under normal circumstances
(non-crisis), regulators should assume a minor role, which will force an increase
in accountability for design and disclosure on the banks. Lastly, this paper will
analyze the regulatory stress testing disclosure process and its effects on market
Read the full paper here.