This paper investigates the validity of banks' credit loss projections in the bi-annual EU-wide bank stress tests, which inform regulatory capital requirements. It finds that banks “re-optimized” their models in 2016 to bring down credit losses, exploiting flexibility in the stress test framework. Specifically, banks whose losses would have increased the most from 2014 to 2016 because of changes in the adverse scenario saw the largest decrease in projected losses thanks to model changes. Upon the release of the 2016 stress test results, stock prices and credit default swap spreads increased more for banks that achieved a greater reduction in credit losses through “re-optimization”, consistent with investors anticipating lower future capital requirements for these banks.

We extend the framework of Aikman et al. (2017) that maps vulnerabilities in the U.S. financial system to a broader set of financial vulnerabilities in 27 advanced and emerging economies. We capture a holistic view of the evolution of financial vulnerabilities before and after a banking crisis. We find that, before a banking crisis, pressures in asset valuations materialize first and then a build-up of imbalances in the external, financial, and nonfinancial sectors occurs. After a crisis, these vulnerabilities subside, but sovereign debt imbalances rise as governments try to mitigate the consequences of the crisis. Our main indexes, which aggregate these vulnerabilities, predicts banking crises better than the credit-to-GDP gap (CGG) or sector-specific vulnerability indexes, especially at long horizons. Our aggregate indexes also explain the variation in the severity of banking crises and the duration of recessions relatively well, as it incorporates possible spillover and amplification channels of financial vulnerabilities from one sector to another. Therefore, our framework is useful for macroprudential policy making and crisis management.

We use supervisory data to investigate the ex-ante credit risk taken by different types of lenders in the U.S. syndicated term loan market during the LSAPs period. We find that nonbank lenders, mutual funds and structured-finance vehicles, take higher risk when longer-term interest rates decrease. The results are stronger for mutual funds that charge higher fees. Banks accommodate other lenders’ investment choices by originating riskier loans and selling them off. These results are consistent with “search for yield” by nonbanks and with a risk-taking channel of monetary policy. Over the sample we study, lower longer-term interest rates appear to have only a minimal effect on loan spreads.

We study the effects of U.S. interest rates and other factors on risk-taking in the global market for U.S. dollar syndicated term loans. We find that, before the Global Financial Crisis, both U.S. and non-U.S. lenders originated ex ante riskier loans to non-U.S. borrowers in response to a decline in short-term U.S. interest rates and, after the crisis, in response to a decline in longer-term U.S. interest rates. After the crisis, this behavior was more prominent for shadow banks and less prominent for banks with relatively low capital. Separately, before the crisis, lenders originated less risky loans in response to U.S. dollar appreciation. Across the periods, the responses to risk appetite and economic uncertainty varied. To the extent that the Federal Reserve affects U.S. interest rates, we provide evidence of global risk-taking spillovers of U.S. monetary policy, which are important but not dominant factors for risk-taking in the market.