Thilo Pausch

Optimal Disclosure of Supervisory Information in the Banking Sector

The game-theoretical analysis of this paper shows that stress tests that cover the entire banking sector (macro stress tests) can be performed by institutional supervisors to improve welfare. In a multi-receiver framework of Bayesian persuasion we show that a banking authority can create value when committing to disclose the stress-testing methodology (signal-generating process) together with the stress test result (signal). Disclosing two pieces of information is a typical procedure used in stress tests. By optimally choosing these two signals, supervisors can deliver superior information to prudent investors and enhance welfare. The paper offers a new theory to explain why stress tests are generally welfare enhancing. We also offer a treatment of the borderline case where the banking sector is hit by a crisis, in which case the supervisor will optimally disclose an uninformative signal.

Risk Sensitivity of Banks, Interbank Markets and the Effects of Liquidity Regulation

The industrial organization approach to banking is extended to analyze the effects of interbank market activity and regulatory liquidity requirements on bank behavior. A multi-stage decision situation allows for considering the interaction between credit risk and liquidity risk of banks. This interaction is found to make a risk neutral bank behave as if it were risk averse in an environment where there is no interbank market and liquidity regulation. Introducing a buoyant interbank money market destroys endogenous risk aversion and allows banks to manage credit risk and liquidity risk independently. The paper shows that a liquidity regulation just like the one proposed in BCBS (2010) is not generally able to offset the separating effect of interbank money markets and recreate endogenous risk aversion of banks.