The impact of non-traditional activities on the estimation of bank efficiency: International evidence

This paper investigates the relevance of non-traditional activities in the estimation of bank efficiency levels using a sample of 752 publicly quoted commercial banks from 87 countries around the world, allowing comparison of the impact of such activities under different levels of economic development, geographical regions and other country characteristics. We estimate both cost and profit efficiency of banks using a traditional function that considers loans and other earnings assets as the only outputs, and two additional functions to account for non-traditional activities, one with off-balance sheet (OBS) items and the other with non-interest income as an additional output. Controlling for cross-country differences in regulatory and environmental conditions, we find that, on average, cost efficiency increases irrespective of whether we use OBS or non-interest income, although the results for profit efficiency are mixed. Our results also reveal that while the inclusion of non-traditional outputs does not alter the directional impact of environmental variables on bank inefficiency, regulations that restrict bank activities and enhance monitoring and supervision provisions improve both cost and profit efficiency.     

Bank activity and funding strategies: The impact on risk and returns

This paper examines the implications of bank activity and short-term funding strategies for bank risk and return using an international sample of 1,334 banks in 101 countries leading up to the 2008 financial crisis. Expansion into noninterest income-generating activities such as trading increases the rate of return on assets, and it could offer some risk diversification benefits at very low levels. Nondeposit, wholesale funding in contrast lowers the rate of return on assets, while it can offer some risk reduction at commonly observed low levels of nondeposit funding. A sizable proportion of banks, however, attract most of their short-term funding in the form of nondeposits at a cost of enhanced bank fragility. Overall, banking strategies that rely prominently on generating noninterest income or attracting nondeposit funding are very risky, consistent with the demise of the US investment banking sector.     

Differential impact of Korean banking system reforms on bank productivity

We study the impact of banking system reforms during a crisis following a period of undisciplined lending. Regulatory changes aimed at strengthening the banks’ capital structure and risk management practices do not have a uniform impact on bank productivity, but rather favor financially sound or strategically privileged banks. We present evidence documenting the differential impact of regulatory reforms on Korean commercial bank productivity over the period 1995–2005. Average technical efficiency of banks decreased during the financial crisis of 1997–1998. It improved following the subsequent bank restructuring and continued to improve through 2005. The capital adequacy ratio is positively associated with banks’ technical efficiency. The non-performing loans ratio is negatively associated with technical efficiency. Both relationships are accentuated during the crisis but attenuated after the reforms.     

The impact of European bank mergers on bidder default risk

We analyze the implications of European bank consolidation on the default risk of acquiring banks. For a sample of 134 bidding banks, we employ the Merton distance to default model to show that, on average, bank mergers are risk neutral. However, for relatively safe banks, mergers generate a significant increase in default risk. This result is particularly pronounced for cross-border and activity-diversifying deals as well as for deals completed under weak bank regulatory regimes. Also, large deals, which pose organizational and procedural hurdles, experience a merger-related increase in default risk. Our results cast doubt on the ability of bank merger activity to exert a risk-reducing and stabilizing effect on the European banking industry.     

Towards a more accurate measure of foreign bank entry and its impact on domestic banking performance: The case of China

This paper examines the impact of foreign bank entry on China’s banking performance. An innovation in this study is that it constructs a spatially disaggregated measure of foreign bank presence, employing location data of foreign bank branches. Using this measure, the study examines the relationship between foreign bank presence and domestic banking performance in China. The results show that the spatially disaggregated measure not only improves the assessment of the impact of foreign bank presence but also resolves unexplained discrepancies found in existing empirical studies contingent on aggregate measures. Importantly, the study provides strong empirical evidence that foreign bank entry is supportive of a more competitive and efficient banking industry in China.     

Loan loss accounting and procyclical bank lending: The role of direct regulatory actions

I provide evidence that loan loss accounting affects procyclical lending through its impact on regulatory actions. Regulators are more likely to place banks with inadequate loan loss allowances under enforcement actions that restrict lending, leading these banks to lend less during downturns. Further, I find that banks with lower regulatory ratings lend less when they have more timely provisions, consistent with research theorizing that timely provisions increase transparency and inhibit regulatory forbearance. This regulatory action mechanism expands on prior research that has focused on the effect of loan loss recognition on regulatory capital adequacy during economic downturns.     

The impact of regulatory reforms on cost structure,ownership and competition in Indian banking

This paper evaluates the impact of financial sector reforms on the cost structure characteristics and on the ownership–cost efficiency relationship in Indian banking. It also examines the impact of reforms on the dynamics of competition in the lending market. We find evidence that deregulation improves banks performance and fosters competition in the lending market. Results suggest technological progress, once Indian commercial banks have adjusted to the new regulatory environment. This, however, does not translate in efficiency gains. There is also evidence of an ownership effect on the level and pattern of efficiency change. Finally, competition keeps building pace even in the re-regulation period and technological improvements are not hampered by the tightening of prudential norms.     

The liquidity of bank assets and banking stability

This paper shows that an increased liquidity of bank assets, paradoxically, increases banking instability and the externalities associated with banking failures. This is because even though higher asset liquidity directly benefits stability by encouraging banks to reduce the risks on their balance sheets and by facilitating the liquidation of assets in a crisis, it also makes crises less costly for banks. As a result, banks have an incentive to take on an amount of new risk that more than offsets the positive direct impact on stability.     

The impact of banking regulations on banks' cost and profit efficiency: Cross-country evidence

This paper uses stochastic frontier analysis to provide international evidence on the impact of the regulatory and supervision framework on bank efficiency. Our dataset consists of 2853 observations from 615 publicly quoted commercial banks operating in 74 countries during the period 2000-2004. We investigate the impact of regulations related to the three pillars of Basel II (i.e. capital adequacy requirements, official supervisory power, and market discipline mechanisms), as well as restrictions on bank activities, on cost and profit efficiency of banks, while controlling for other country-specific characteristics. Our results suggest that banking regulations that enhance market discipline and empower the supervisory power of the authorities increase both cost and profit efficiency of banks. In contrast, stricter capital requirements improve cost efficiency but reduce profit efficiency, while restrictions on bank activities have the opposite effect, reducing cost efficiency but improving profit efficiency.     

Bank capital buffer and portfolio risk: The influence of business cycle and revenue diversification

The relationship between macroeconomic developments and bank capital buffer and portfolio risk adjustments is relevant to assess the efficacy of newly created countercyclical buffer requirements. Using the U.S. bank holding company data over the period 1992:Q1–2011:Q3, we find a negative relationship between the business cycle and capital buffer. Our results offer some support for the Basel III agreements that countercyclical capital buffer in the banking sector is necessary to help the performance of the real economy during recessions. We find a robust evidence of inverse relationship between business cycle and bank default risk. Our analysis provides evidence of diversification benefits. The probability of insolvency risk decreases for diversified banks and banks with high revenue diversity achieve capital savings.     

Systemically important banks and financial stability: The case of Latin America

This paper addresses the issue on how bank size and market concentration affect performance and risks in 17 Latin American countries between 2001 and 2008. The objective is to evaluate whether a too-big-to-fail behavior has been present in the region. Surprisingly, we do not find evidence to support a higher fragility of large Latin American banks. Our results show that systemically important financial institutions appear to outperform others in terms of both cost and profit without the need of taking more risks. This result holds even in concentrated markets, i.e., where there are few dominant banks and many others with small size in relation to the market. A highly unequal banking market in terms of assets, however, is detrimental for the performance of smaller banks and it also decreases stability of the whole system. We conclude that regulators should deal with market concentration by reducing the size gap between large and small banks, instead of dealing specifically with systemically important banks.     

The impact of banking sector reform in a transition economy: Evidence from Kyrgyzstan

We examine the impact of financial sector reform on interest rate levels and spreads using Kyrgyz bank-level data from 1998 to 2005. We find that, in addition to macroeconomic stabilization, structural reforms to the banking sector significantly contributed to lower interest rates. In particular, our results suggest that foreign bank entry and regulatory efforts to increase average bank size were important in reducing deposit rates. In contrast, we find little evidence that banking sector reform or macroeconomic stabilization has impacted interest rate spreads.     

The effects of reform on China’s bank structure and performance

This paper investigates the relationship between market structure and performance in China’s banking system from 1985 to 2002, a period when this sector was subject to gradual but notable reform. Using panel data estimation techniques, both the market-power and efficient-structure hypotheses are tested. In addition, the model is extended to consider issues such as the impact of bank size/ownership and whether the big four banks enjoy a “quiet life”. On average, X-efficiency declined significantly and most banks were operating below scale efficient levels. Estimation of the structure–performance models lends some support to the relative market-power hypothesis in the early period. The reforms had little impact on the structure of China’s banking sector, though the “joint stock” banks became relatively more X-efficient. There was no evidence to support the quiet-life hypothesis, probably because strict interest rate controls prevented the state banks from earning monopoly profits. Thus the ongoing liberalisation of interest rates should be accompanied by reduced concentration. Overall, to improve competitive structure, new policies should be directed at encouraging market entry and increasing the market share of the most efficient banks.     

The optimal structure of PD buckets

In designing credit rating systems under the new Basel Accord, considerable effort has been devoted to rating assignment and quantification, while the choice of the optimal bucket structure has received less attention. To fill this gap, we propose two “bucketing” strategies based on constrained optimisation, paying attention to the implications of rating buckets for loan-pricing and adverse selection phenomena. We compare them with some more naïve approaches, based on a sample of about 100,000 European companies. We also analyse the persistence of our performance measures over time, as well as the effect of large exposures being associated with low-PD obligors.     

The determinants of bank loan recovery rates

Using Moody’s Ultimate Recovery Database, we estimate a model for bank loan recoveries using variables reflecting loan and borrower characteristics, industry and macroeconomic conditions, and several recovery process variables. We find that loan characteristics are more significant determinants of recovery rates than are borrower characteristics prior to default. Industry and macroeconomic conditions are relevant, as are prepackaged bankruptcy arrangements. We examine whether a commonly used proxy for recovery rates, the 30-day post-default trading price of the loan, represents an efficient estimate of actual recoveries and find that such a proxy is biased and inefficient.     

The use of blanket guarantees in banking crises

Policymakers often use guarantees on bank liabilities to prevent or contain bank runs during systemic banking crises, but their success has been debated. Using a sample of 42 episodes of banking crises, this paper finds that blanket guarantees do help to reduce liquidity pressures on banks, but only partially since they do not stem withdrawals from non-residents. Withdrawals following the announcement of guarantees are much more pronounced for non-resident liabilities than for foreign-currency denominated deposits—which may also be held by residents—suggesting that the results on non-residents are not driven by foreign-currency risk but by concerns about the government’s ability and commitment to honor the guarantee to non-resident liability holders.     

The cyclical behaviour of European bank capital buffers

Using an unbalanced panel of accounting data from 1997 to 2004 and controlling for individual bank costs and risk, we find capital buffers of the banks in the EU15 have a significant negative co-movement with the cycle. For banks in the accession countries there is significant positive co-movement. Capital buffers of commercial and savings banks, and of large banks, exhibit negative co-movement. Those of co-operative and smaller banks exhibit positive co-movement. Speeds of adjustment are fairly slow. We interpret these results and discuss policy implications, noting that negative co-movement of capital buffers will exacerbate the pro-cyclical impact of Basel II.     

The light and dark side of TARP

This paper empirically investigates the impact of the first announcement of TARP, the announcement of revised TARP, respective capital infusions under TARP–CPP and capital repayments on changes in shareholder value and the risk exposure of supported US banks. Our analysis reveals a light and a dark side of TARP. While announcements as well as capital repayments may provoke positive wealth effects and a decrease in bank risk, equity capital injections to banks are observed to be a severe impediment to restore market confidence and financial stability. Furthermore, while TARP announcements and capital injections may increase systemic risk, no significant effect on systemic risk is found for capital repayments.     

The level and quality of Value-at-Risk disclosure by commercial banks

In this paper we study both the level of Value-at-Risk (VaR) disclosure and the accuracy of the disclosed VaR figures for a sample of US and international commercial banks. To measure the level of VaR disclosures, we develop a VaR Disclosure Index that captures many different facets of market risk disclosure. Using panel data over the period 1996–2005, we find an overall upward trend in the quantity of information released to the public. We also find that Historical Simulation is by far the most popular VaR method. We assess the accuracy of VaR figures by studying the number of VaR exceedances and whether actual daily VaRs contain information about the volatility of subsequent trading revenues. Unlike the level of VaR disclosure, the quality of VaR disclosure shows no sign of improvement over time. We find that VaR computed using Historical Simulation contains very little information about future volatility.     

A geographically weighted approach to measuring efficiency in panel data: The case of US saving banks

This paper discusses a new approach to controlling for the environment when estimating efficiency. In response to the literature on the international comparison of bank efficiency, we draw the attention to a local dimension of comparison. By introducing geographical weights and estimating local frontiers for each US savings bank in the 2001–09 period, we find that the bank technical performance is higher for most banks in comparison to a fixed-effects approach. This result highlights the importance of taking into account the local environment and constraints while analyzing banks’ performance, so as not to consider the factors that are exogenous to these institutions as inefficiencies. Further analysis could improve the weighs calculation by employing other measures of interconnectedness besides geographical distance.