Stress Testing and Bank Efficiency: Evidence from Europe

Stress Testing and Bank Efficiency: Evidence from Europe

Iftekhar Hasan (Gabelli School of Business, Fordham University, New York City, NY, USA and Bank of Finland, Helsinki, Finland) and Fotios Pasiouras (Surrey Business School, University of Surrey, Guildford, UK & Financial Engineering Laboratory, Technical University of Crete, Chania, Greece)
Copyright: © 2015 |Pages: 20
DOI: 10.4018/IJCFA.2015070101
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This study examines whether and how the stress testing of European banks in 2010, 2011, and 2014 is related to their technical, allocative, and cost efficiency. Using a sample of large commercial banks operating in 20 European countries, and Data Envelopment Analysis (DEA), the authors perform comparisons between banks that were included in one of the three European stress tests and untested banks operating in the same countries. They estimate various specifications as for the inputs and outputs, cross-section and pooled estimations, and they also examine alternative samples as for the ownership of banks. In general, the authors conclude that banks included in the stress-test exercises are more efficient that their counterparties. The differences tend to be statistically significant in the case of allocative efficiency and cost efficiency, but not in the case of technical efficiency. With regards to the latter form of efficiency, the results depend upon the specification and the stress test in question.
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1. Introduction

The efficiency of banking institutions has received considerable attention in the literature.1Some of the studies provide a comparison of alternative techniques for the estimation of efficiency (e.g. Bauer et al., 1998), whereas others attempt to reveal the driving factors of efficiency.2A small but growing number of studies that fall into the latter strand of this literature examine the role of market discipline and disclosure requirements. Most of these studies make use of information from the World Bank Database on Bank Regulation and Supervision to develop proxies of disclosure requirements, which they then relate to bank efficiency (e.g. Pasiouras, 2008; Barth et al., 2013).Others examine alternative proxies of transparency like the number of analysts following a bank and transparency ratings (e.g. Akhigbe et al., 2013; Farvaque et al., 2012). In general, these studies tend to conclude that enhanced disclosure requirements improve bank efficiency.

In the present study, we follow a different approach. More precisely, we examine whether and how stress testing, as a tool that enhances transparency and market discipline, influences bank efficiency. The main hypothesis according to the private monitoring empowerment view is that improved private governance of banks (i.e. by market participants) will boost their functioning (Barth et al., 2007) and consequently their efficiency.

The idea that stress testing can reduce bank opaqueness is not new.For example, as highlighted in Neretina et al. (2014), Bernake stated in 2013 that “Even outside of a period of crisis, the disclosure of stress test results and assessments provides valuable information to market participants and the public, enhances transparency, and promotes market discipline”. This is possibly why the number of countries publishing bank stress tests has significantly increased, from 0 to over 40 in recent years (Horváth and Vaško, 2013). Within this context, the 2011 stress test of the European Banking Authorityled to the release of around 3,400 data points for each of the 90 participating banks.This was followed by an even more remarkable attempt to improve bank transparency during the 2014 stress test, with the disclosed data points increasing to up to 12,000 for each one of the 123 banks involved in this exercise. As a result of the interest in the disclosure of stress testing, various recent studies examined their impact on capital markets, focusing mostly on CDS spreads and equity returns (e.g. Alves et al., 2013; Petrella and Resti, 2013; Ellahie, 2013). These studies tend to conclude that the stress-tests provide valuable information to market participants.

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