{"id":1608,"date":"2012-06-14T10:04:11","date_gmt":"2012-06-14T00:04:11","guid":{"rendered":"http:\/\/blogs.unsw.edu.au\/knowledgetoday\/?p=1608"},"modified":"2012-06-14T10:04:11","modified_gmt":"2012-06-14T00:04:11","slug":"bankrun","status":"publish","type":"post","link":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/blog\/2012\/06\/bankrun\/","title":{"rendered":"Avoiding the Slippery Slope toward a Bank Run"},"content":{"rendered":"

From the Knowledge@Wharton today\u00a0blog<\/a>.<\/strong><\/p>\n

Those who may chuckle at the cutting phrase \u201cno good deed goes unpunished\u201d might appreciate how it fits today\u2019s banking crisis in one respect: Regulators who, post-crisis, devised so-called stress tests to uncover \u2013 and ultimately repair \u2013 bank weaknesses, could inadvertently spark a bank run by disclosing the test results. Yet, without some level of public disclosure, the stress tests might not have the intended market disciplinary effect.<\/p>\n

But there is a path away from this dilemma, according to a recent paper by Wharton finance professor Itay Goldstein<\/a> and his colleague, Haresh Sapra of the University of Chicago Booth School of Business. In the paper, titled \u201cShould Banks\u2019 Stress Test Results be Disclosed? An Analysis of the Costs and Benefits<\/a>,\u201d the two argue that some fixes to the stress test process could beef up weak banks by identifying problems before they blow up and also guard against damaging disclosures that could trigger a bank run.<\/p>\n

\u201cThe disclosure of stress test results can be beneficial because they promote financial stability,\u201d says Goldstein, and they can be \u201cquite useful in providing market discipline for individual banks and helping with the accountability of regulators.\u201d That all provides the right incentives.<\/p>\n

But given banks\u2019 deep vulnerability to the disclosure of financial deficiencies, indiscriminant disclosure can cause problems. If depositors and investors lose confidence, they will withdraw their money and possibly cause a bank to fail. And when disclosure makes bad news public, markets tend to amplify it, Goldstein points out. Even those who may believe a bank under fire is actually sound will abandon the institution because they must account for \u201cwhat others may think.\u201d A bank-run scenario can become a self-fulfilling prophecy, so regulators must carefully consider what information to release.<\/p>\n

What is more, publicly disclosing stress test results can have an adverse effect on the behavior of bank managers, who may game the system by putting too many resources toward passing the stress test, rather than doing what is best long term. \u201cIf a manager does not know [the test criteria] there is less room for manipulation or gaming,\u201d Goldstein says.<\/p>\n

The authors\u2019 recommendations? Any disclosure of problems with an individual bank should be precise \u2013 to avoid misunderstandings \u2013 and should come with a prescription for corrective action, so that markets can see that the situation is not necessarily dire. \u201cThe danger arises if we just say we found that a bank is in trouble, and don\u2019t follow up with action,\u201d Goldstein says. Instead, the message should be \u201cWe found a problem and now we are taking these steps to make things better.\u201d<\/p>\n

If regulators cannot meet that bar, then they should instead issue a system-wide evaluation offering aggregate results, and avoid singling out any one bank. While stress testing can be good for the banking system as a whole, regulators have to be \u201cmore careful with individual banks,\u201d Goldstein points out.<\/p>\n

System-wide disclosure can also moderate a more subtle challenge, where disclosure can adversely affect the inner workings of the market \u2013 specifically, how investors trade based on information. Market prices reflect the total information held by market participants, who trade on it. Once regulators provide more information via disclosure, some participants may feel they are losing their information advantage and thus could lose interest in trading in the area. That makes it more difficult for regulators to learn about the market from price signals, which in turn could degrade the regulatory effort. Aggregated disclosure can also help sidestep that problem.<\/p>\n

So, could stress tests, introduced after the financial meltdown, have prevented the disaster? \u201cThey potentially could have made banks more prepared and reduced the extent\u201d of the crash, Goldstein says. \u201cBut it\u2019s always a challenge. We are prepared for things that happened in the past,\u201d not in the present. \u201cPeople talked about subprime and fragility for some time before the crisis, but the common thought was that it was a local problem that could affect some banks, but any damage would be contained and so it was not a big problem. They failed to understand the macro or general equilibrium implications \u2014 once one banks folds, it affects others that are connected to it and this contagion was hard to predict\u2026. You can\u2019t predict everything.\u201d<\/p>\n

Once a crisis is underway, however, full disclosure is the best course. \u201cThere is no choice but to disclose during a crisis.\u201d There already is so little confidence that not disclosing at that point could cause more damage, though disclosure probably \u201cwill not help much.\u201d<\/p>\n

This post previously appeared in the Knowledge@Wharton today<\/a>\u00a0blog: Avoiding the Slippery Slope toward a Bank Run<\/a><\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

From the Knowledge@Wharton today\u00a0blog. Those who may chuckle at the cutting phrase \u201cno good deed goes unpunished\u201d might appreciate how it fits today\u2019s banking crisis in one respect: Regulators who, post-crisis, devised so-called stress tests to uncover \u2013 and ultimately repair \u2013 bank weaknesses, could inadvertently spark a bank run by disclosing the test results. […]<\/p>\n","protected":false},"author":336,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[4755],"tags":[],"class_list":["post-1608","post","type-post","status-publish","format-standard","hentry","category-finance"],"_links":{"self":[{"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/posts\/1608","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/users\/336"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/comments?post=1608"}],"version-history":[{"count":2,"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/posts\/1608\/revisions"}],"predecessor-version":[{"id":1610,"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/posts\/1608\/revisions\/1610"}],"wp:attachment":[{"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/media?parent=1608"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/categories?post=1608"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.unsw.edu.au\/BTOpinion\/wp-json\/wp\/v2\/tags?post=1608"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}