Stressed Banks? Evidence from the Largest-Ever Supervisory Review

We study short-term and medium-term changes in bank risk-taking as a result of supervision and the associated real effects. For identification, we exploit the European Central Bank’s asset-quality-review (AQR) in conjunction with security and credit registers. After the AQR announcement, reviewed banks reduce riskier securities and credit supply, with the greatest effect on riskiest securities. We find negative spillovers on asset prices and firm-level credit availability. Moreover, nonbanks with higher exposure to reviewed banks acquire the shed risk. After the AQR compliance, reviewed banks reload riskier securities but not riskier credit, resulting in negative medium-term firm-level real effects. These effects are especially strong for firms with high ex ante credit risk. Among these nonsafe firms, even those with high ex ante productivity, experience negative real effects. Our findings suggest that banks’ liquid assets help them to mask risk from supervisors and risk adjustments banks make in response to supervision have persistent corporate real effects. This paper was accepted by Victoria Ivashina, finance. Funding: J.-L. Peydró acknowledges financial support from the BBVA Foundation [2018 Leonardo Grant for Researchers and Cultural Creators], the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme [Grant Agreement 648398], the MCIU/AEI/FEDER, UE [Grant PGC2018-102133-B-I00], and the Spanish Ministry of Economy and Competitiveness, through the Severo Ochoa Programme for Centres of Excellence in R&D [Grant SEV-2015-0563]. The analysis, conclusions, and opinions set forth in the paper are solely those of the authors and do not necessarily represent the views of the Bundesbank, Eurosystem, Federal Reserve Board, or the United States. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2020.01714 .