Bank Recapitalization,Regulatory Intervention,and Repayment

We use prudential supervisory data for all German banks during 1994–2010 to test if regulatory interventions affect the likelihood that bailed‐out banks repay capital support. Accounting for the selection bias inherent in nonrandom bank bailouts by insurance schemes and the endogenous administration of regulatory interventions, we show that regulators can increase the likelihood of repayment substantially. An increase in intervention frequencies by one standard deviation increases the annual probability of capital support repayment by 7%. Sturdy interventions, like restructuring orders, are effective, whereas weak measures reduce repayment probabilities. Intervention effects last up to 5 years.     

Time‐Varying Capital Requirements and Disclosure Rules: Effects on Capitalization and Lending Decisions

We investigate how banks’ capital and lending decisions respond to changes in bank‐specific capital and disclosure requirements. We find that an increase in the bank‐specific regulatory capital requirement results in a higher bank capital ratio, brought about via less asset risk. A decrease in the requirement implies more lending to firms but also less Tier 1 capital and higher bank leverage. We do not observe differences between confidential and public disclosure of capital requirements. Our results empirically illustrate a tradeoff between bank resilience and a fostering of the economy through more bank lending using banks’ capital requirement as policy instrument.     

Liquidity Provision,Bank Capital,and the Macroeconomy

New bank equity must come from somewhere. In general equilibrium, raising bank capital requirements means either that banks produce less short‐term debt (as debt holders must become shareholders), or short‐term debt is not reduced and the banking system acquires nonbank equity (as the shareholders in nonbanks become shareholders in banks). The welfare effects involve a trade‐off because bank debt is special as it is used for transactions purposes, but more bank capital can reduce the chance of bank failure (producing welfare losses).     

A framework for assessing the systemic risk of major financial institutions

In this paper we propose a framework for measuring and stress testing the systemic risk of a group of major financial institutions. The systemic risk is measured by the price of insurance against financial distress, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations. Importantly, using realized correlations estimated from high-frequency equity return data can significantly improve the accuracy of forecasted correlations. Our stress testing methodology, using an integrated micro–macro model, takes into account dynamic linkages between the health of major US banks and macro-financial conditions. Our results suggest that the theoretical insurance premium that would be charged to protect against losses that equal or exceed 15% of total liabilities of 12 major US financial firms stood at $110 billion in March 2008 and had a projected upper bound of $250 billion in July 2008.     

Did the Market Signal Impending Problems at Northern Rock? An Analysis of Four Financial Instruments

The academic literature has regularly argued that market discipline can support regulatory authority mechanisms in ensuring banking sector stability. This includes, amongst other things, using forward‐looking market prices to identify those credit institutions that are most at risk of failure. The paper's key aim is to analyse whether market investors signalled potential problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities at the Bank of England in September 2007. A further aim of the paper is to examine the signalling qualities of four financial market instruments (credit default swap spreads, subordinated debt spreads, implied volatility from options prices and equity measures of bank risk) so as to explore both the relative and individual qualities of each. The paper's findings, therefore, contribute to the market discipline literature on using market data to identify bank risk‐taking and enhancing supervisory monitoring. Our analysis suggests that private market participants did signal impending financial problems at Northern Rock. These findings lend some empirical support to proposals for the supervisory authorities to use market information more extensively to improve the identification of troubled banks. The paper identifies equities as providing the timeliest and clearest signals of bank condition, whilst structural factors appear to hamper the signalling qualities of subordinated debt spreads and credit default swap spreads. The paper also introduces idiosyncratic implied volatility as a potentially useful early warning metric for supervisory authorities to observe.     

Bank Capital: Lessons from the Financial Crisis

Using a multicountry panel of banks, we study whether better capitalized banks experienced higher stock returns during the financial crisis. We differentiate among various types of capital ratios: the Basel risk‐adjusted ratio, the leverage ratio, the Tier 1 and Tier 2 ratios, and the tangible equity ratio. We find several results: (i) before the crisis, differences in capital did not have much impact on stock returns; (ii) during the crisis, a stronger capital position was associated with better stock market performance, most markedly for larger banks; (iii) the relationship between stock returns and capital is stronger when capital is measured by the leverage ratio rather than the risk‐adjusted capital ratio; (iv) higher quality forms of capital, such as Tier 1 capital and tangible common equity, were more relevant.     

Bank connections,corporate investment and crisis

Against the backdrop of a severe financial crisis and extensive restructuring of the financial sector, we investigate the evolution and determinants of connections between firms and banks, and the impact of bank connections on corporate investment. Our study examines Thai non-financial companies during 1995–2000, a period straddling the East Asian Financial Crisis of 1997–1998. Before the crisis, bank-connections are common and associated with significantly lower sensitivity of corporate investment to internal cash flow. After the crisis, and following substantial changes in bank ownership and governance due to financial-sector reforms and restructuring, far fewer firms are bank-connected and connections no longer affect investment–cash flow sensitivity.     

Optimal Bank Transparency

Increasing transparency is recurrently offered as a centerpiece of bank regulation. We study a competitive banking sector whose illiquid assets are funded by short‐term debt that must be refinanced. We show that welfare is a nonmonotonic function of the level of transparency: Increasing transparency fosters efficient liquidation but has an adverse effect on rollover risk given the level of risk. Banks may compensate this adverse effect by taking more risk. These offsetting effects render an intermediate level of transparency optimal. Moreover, the existence of negative social externalities of bank failures calls for making banks more opaque rather than more transparent.     

The Roles of Corporate Governance in Bank Failures during the Recent Financial Crisis

We analyze the roles of bank ownership, management, and compensation structures in bank failures during the recent financial crisis. Our results suggest that failures are strongly influenced by ownership structure: high shareholdings of lower‐level management and non‐chief executive officer (non‐CEO) higher‐level management increase failure risk significantly. In contrast, shareholdings of banks’ CEOs do not have a direct impact on bank failure. These findings suggest that high stakes in the bank induce non‐CEO managers to take high risks due to moral hazard incentives, which may result in bank failure. We identify tail risk in noninterest income as a primary risk‐taking channel of lower‐level managers.     

Bank Capital Regulation of Trading Portfolios: An Assessment of the Basel Framework

In setting minimum capital requirements for trading portfolios, the Basel Committee on Banking Supervision (1996, 2011a, 2013) initially used Value‐at‐Risk (VaR), then both VaR and stressed VaR (SVaR), and most recently, stressed Conditional VaR (SCVaR). Accordingly, we examine the use of SCVaR to measure risk and set these requirements. Assuming elliptically distributed asset returns, we show that portfolios on the mean‐SCVaR frontier generally lie away from the mean‐variance (M‐V) frontier. In a plausible numerical example, we find that such portfolios tend to have considerably higher ratios of risk (measured by, e.g., standard deviation) to minimum capital requirement than those of portfolios on the M‐V frontier. Also, we find that requirements based on SCVaR are smaller than those based on both VaR and SVaR but exceed those based on just VaR. Finally, we find that requirements based on SCVaR are less procyclical than those based on either VaR or both VaR and SVaR. Overall, our paper suggests that the use of SCVaR to measure risk and set requirements is not a panacea.     

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.     

An empirical analysis of the economic impact of federal terrorism reinsurance

This paper examines the role of the federal government in the market for terrorism reinsurance. We investigate the stock price response of affected industries to a sequence of 13 events culminating in the enactment of the Terrorism Risk Insurance Act (TRIA) of 2002. In the industries most likely to be affected by TRIA—banking, construction, insurance, real estate investment trusts, transportation, and public utilities-the stock price effect was primarily negative. The Act was at best value-neutral for property-casualty insurers because it eliminated the option not to offer terrorism insurance. The negative response of the other industries may be attributable to the Act's impeding more efficient private market solutions, failing to address nuclear, chemical, and biological hazards, and reducing market expectations of federal assistance following future terrorist attacks.     

Market discipline and too-big-to-fail in the CDS market: Does banks' size reduce market discipline?

This paper examines market discipline in the credit default swap (CDS) market and the potential distortion of CDS spreads which arises when a bank is thought to be too-big-to-fail. Overall, we find evidence for market discipline in the CDS market. However, CDS prices are distorted by a size effect when a bank is considered to be too-big-to-fail. A 1 percentage point increase in size reduces the CDS spread of a bank by about 2 basis points. We further find that some banks have already reached a size that makes them too-big-to-be-rescued. While the price distortion for these banks decreases, the existence of banks that are considered to be too-big-to-rescue raises important new issues for banking supervisors.     

Regulation fair disclosure and the market’s reaction to analyst investment recommendation changes

Previous research has shown that affiliated analysts (those who are working for investment banks that underwrite securities for companies) have an incentive to provide optimistically biased recommendations from selective information they are given by the firm. In an effort to halt such activities, as of October 2000, Regulation Fair Disclosure (RegFD) prohibits selective disclosure of material non-public information by public companies to privileged individuals (such as favored research analysts) and requires broad, non-exclusionary disclosure of such information. We examine firms’ stock price reactions to investment recommendation changes from affiliated analysts versus unaffiliated analysts from October 1998 to November 2002, around the passage of RegFD. Similar to previous research, we find that investors reacted more significantly to recommendation downgrades by affiliated analysts than to those by unaffiliated analysts prior to the passage of RegFD. However, we find that the difference in the reactions to recommendation changes is not present after the passage of RegFD. We also find that stock price reactions to analysts’ (both affiliated and unaffiliated) recommendation changes decreased significantly after the passage of RegFD. Thus, RegFD appears to have curbed the selective disclosure of information (particularly negative information) by firms to affiliated analysts. Further, the smaller reactions to recommendation changes by all analysts after RegFD may reflect a change in analysts’ behavior (irrespective of information that is available) or a response by corporate managers to withhold information rather than risking a violation of fair disclosure rules.     

Detecting insider trading: The theory and validation in Korea Exchange

This paper provides an empirical basis for identifying insider transactions by deriving a theoretical model, which incorporates the relationship between insider transactions and time series of stock returns. Thus, this model enables us detecting insider transactions by applying stock return time series. We show that when there is an insider transaction in the market, time series can be derived as an ARMA(1,1) process having closed solution coefficients. For validation of the model, we test publicly released insider transactions and reverse takeover events using the minute-by-minute stock price data. The selected events show higher pass rate of the detection criteria than the current detection system which shows that our model produces smaller Type II error than the existing post transaction-based cumulative abnormal return model.