Disclosure of Stress Test Results

The author examines the tradeoffs in a world in which examination results can be kept confidential, but regulatory interventions are observable by market participants, as they typically are for stress tests. Inducing banks to communicate truthfully requires regulators to engage in forbearance, which is priced into banks’ uninsured debt and raises the costs of inducing truthful communication. Regulators that disclose exam results bear higher monitoring costs and impose excessive capital requirements because interventions are not as sensitive to underlying risks. The author's model predicts that disclosure is optimal when the regulator’s model is relatively inaccurate.