The Coordination Role of Stress Test Disclosure in Bank Risk Taking

We examine whether stress-test disclosures distort banks’risk-taking decisions. We study a model in which a regulator may choose to rescue banks in the event of concurrent bank failures. Our analysis reveals a novel coordination role of stress-test disclosures. By disclosing stress tests, a regulator informs all banks of the failure likelihood of other banks, which facilitates bank’s coordination in risk-taking. We …nd that disclosing stress tests always increases the rate of bank failure and, unless bank failure externalities are su¢ ciently severe, disclosure also increases banks’average risk and the bailout likelihood.