Dynamic Transparency and Rollover Risk

Abstract

Regulatory disclosures, such as supervisory bank stress tests, are pre-scheduled and conducted on a regular basis to improve transparency and enhance market discipline. We build a dynamic model with asymmetric information to investigate the effectiveness of such regulatory disclosures. We find that banks and bank creditors strategically respond to the anticipated information from pre-scheduled disclosure by shortening debt maturity and requesting higher interest rates, thereby intensifying rollover risk. This negative consequence can outweigh the positive effect from screening out bad investments and make the regulatory disclosure ineffective in promoting stability and efficiency, especially when the improvement of transparency is only moderate and when the market possesses little information about individual banks' financial soundness. Our study highlights the limited effectiveness of pre-scheduled disclosure during a crisis time, provides a rationale for the BOE's and EBA's suspension of regular supervisory stress tests during the COVID-19 pandemic outbreak, and sheds light on a better design of regulatory disclosure.