Resaleable debt and systemic risk

Many debt claims, such as bonds, are resaleable; others, such as repos, are not. There was a fivefold increase in repo borrowing before the 2008–2009 financial crisis. Why? Did banks’ dependence on non-resaleable debt precipitate the crisis? In this paper, we develop a model of bank lending with credit frictions. The key feature of the model is that debt claims are heterogenous in their resaleability. We find that decreasing credit market frictions leads to an increase in borrowing via non-resaleable debt. Such borrowing has a dark side: It causes credit chains to form, because, if a bank makes a loan via non-resaleable debt and needs liquidity, it cannot sell the loan but must borrow via a new contract. These credit chains are a source of systemic risk, as one bank’s default harms not only its creditors but also its creditors’ creditors. Overall, our model suggests that reducing credit market frictions may have an adverse effect on the financial system and even lead to the failures of financial institutions.     

Does market discipline impact bank charter value? The case for Australia and Canada

This study analyses the relation between market discipline and bank charter value using a panel data set of publicly listed domestic banks in Australia and Canada over the period of 1995–2011, with a focus on the 2007–2008 global financial crisis (GFC). Overall, the results show a positive relation between market discipline and bank charter value, but this relation is weaker in the post‐GFC period. Our findings reveal that in the presence of market discipline, bank capital, contingent liabilities and non‐interest income are important sources of charter value. These findings have important policy implications related to bank stability. The results are robust to several model specifications.     

Basel II and the Need for Bank Distress Resolution Procedures*

It is argued that without increased market discipline Basel II is not likely to resolve the regulatory problem caused by explicit and implicit guarantees of depositors and other creditors of banks. One way to enhance market discipline is to implement proposals for mandatory subordinated debt. For these proposals to achieve their objective, the non‐insurance of holders of subordinated debt must be credible. Increased credibility of non‐insurance of one or several groups of creditors could be enhanced if distress resolution procedures for banks were pre‐specified, and if they made possible bank failures without serious disruption of the financial system. The existence of rules for dealing with banks in distress not only enhances the credibility of non‐insurance of some creditors, it also allows for predictability of distress resolution costs for shareholders and management of banks. Such costs—if predictable—reduce the moral hazard incentives caused by deposit insurance schemes.     

Internet finance development and banking market discipline: Evidence from China

Depositor discipline is the only viable and universal source of banking market discipline in China. This paper investigates whether the depositor discipline of banking works in the context of an emerging economy under financial repression and implicit government guarantee, such as the Chinese economy; how banking market discipline is affected by Internet finance development; and whether the impact of Internet finance development on market discipline changes across heterogeneous banks. The results suggest that, in general, measures of bank risk are negatively associated with the growth of deposit volumes. Internet finance development alters the sensitivity of deposit growth ratios to some bank risk measures. For non-state-owned banks, fewer measures of bank risk are significantly negatively associated with the growth of deposit volumes, and the attenuation impact of Internet finance development on market discipline for bank capitalization instead relatively increases. For large banks, market discipline works significantly, except in the case of the bank capitalization variable; moreover, these significant market disciplines are strengthened with the development of Internet finance.     

Banking Market Size Structure and Financial Stability: Evidence from Eight Asian Countries

Using commercial bank data from eight major Asian countries, we examine the relationship between the banking market size structure and the stability of financial institutions. We also analyze the effect of bank upsizing on the financial stability. Our results show that a rise in large banks’ market power, accompanying an increase in their market shares, lowers the capital adequacy of small banks. Small banks’ nonperforming loans and the possibility of their bankruptcy also increase as large banks’ market shares rise. We further show that larger banks tend to have lower capital adequacy ratios, liquidity ratios, and distance-to-default ratios. Our study suggests that large banks’ greater market shares are associated with small banks’ financial instability. Overall, these findings are consistent with the notion of the recent banking literature that has important antitrust policy implications.     

Market price accounting and depositor discipline: The case of Japanese regional banks

We examine the determinants of Japanese regional bank pricing-to-market decisions and their impact on the intensity of depositor discipline, in the form of the sensitivity of deposit growth to bank financial conditions. To obtain consistent estimates, we first model and estimate the bank pricing-to-market decision and then estimate the intensity of depositor discipline after conditioning for that decision. We find that banks were less likely to adopt market price accounting the larger were their unrealized securities losses. We also find statistically significant evidence of depositor discipline among banks that elected to price to market. Our results indicate that depositor discipline was more intense for the subset of banks that adopted market price accounting.     

Market discipline in international banking regulation: Keeping the playing field level

The focus of this article is the debt market as a powerful disciplinarian source for large and complex banking organizations around the world. We empirically study the interactions between reinforcing banks’ market discipline and preserving a level playing field in international banking. Our approach consists of conducting cross-country comparisons of the secondary market prices sensitivity to market measures of bank risk (traditional and financial strength ratings). The results are generally consistent with the market discipline paradigm. However, much progress still needs to be made (especially in Japan and certain European countries) in order to make the level playing field principle compatible with the reinforcement of market discipline on an international level.     

Liquidity risk in securities settlement

This paper studies the potential impact on securities settlement systems (SSSs) of a major market disruption, caused by the default of the largest player. A multi-period, multi-security model with intraday credit is used to simulate direct and second-round settlement failures triggered by the default, as well as the dynamics of settlement failures, arising from a lag in settlement relative to the date of trades. The effects of the defaulter’s net trade position, the numbers of securities and participants in the market, and participants’ trading behavior are also analyzed.We show that in SSSs – contrary to payment systems – large and persistent settlement failures are possible even when ample liquidity is provided. Central bank liquidity support to SSSs thus cannot eliminate settlement failures due to major market disruptions. This is due to the fact that securities transactions involve a cash leg and a securities leg, and liquidity can affect only the cash side of a transaction. Whereas a broad program of securities borrowing and lending might help, it is precisely during periods of market disruption that participants will be least willing to lend securities.Settlement failures can continue to occur beyond the period corresponding to the lag in settlement. This is due to the fact that, upon observation of a default, market participants must form expectations about the impact of the default, and these expectations affect current trading behavior. If, ex post, fewer of the previous trades settle than expected, new settlement failures will occur. This result has interesting implications for financial stability. On the one hand, conservative reactions by market participants to a default – for example by limiting the volume of trades – can result in a more rapid return of the settlement system to a normal level of efficiency. On the other hand, limitation of trading by market participants can reduce market liquidity, which may have a negative impact on financial stability.     

市场约束、流动性援助与存款保险——基于银行审慎经营的激励兼容分析

银行审慎经营是金融稳定的微观基础，而银行治理过程中利益相关者的动态均衡是银行审慎经营的保证。市场约束是利益相关者参与银行治理的外部机制，流动性援助和存款保险是维护金融稳定的安全设施，市场约束、流动性援助和存款保险的激励兼容才能增加银行审慎经营可能性。在一定的制度设施基础上。完善市场约束，减少流动性援助和存款保险带来的道德风险，建立一个市场约束、流动性援助和存款保险激励兼容的外部框架有利于银行的审慎经营。     

影响商业银行稳定的微观因素

本文运用14家上市商业银行2003~2010年的数据,实证研究了银行稳定与信息披露的关系。中国商业银行的稳定性在逐渐增强,信息披露在一定程度上促进了银行稳定性。进一步发挥信息披露的市场约束作用,需要完善相应的制度环境和市场基础。银行资产规模以及利润的增长有效地促进了商业银行的稳定性。国有银行有国家信用的担保,而股份制银行具备相对完善的治理制度,两者的稳定性并不存在显著性的差别。政府应完善信息披露制度,为投资者提供全面、及时、真实的财务信息,加强信息披露的市场约束作用,加强对银行信息披露的监管。     

Determinants of Bank Distress in Europe: Evidence from a New Data Set

Using a unique data set on bank distress, this paper provides novel empirical evidence on the determinants of bank soundness in the European Union (EU) as a whole. The estimation results are consistent with the hypothesis that bank risks have converged across EU members, providing empirical support for introduction of a more centralized system of financial regulation in the EU. We show that asset quality and earning profile of banks are important determinants of bank distress next to leverage, suggesting that these should be central in EU-wide financial regulation and supervision. We find that market discipline, both by depositors and by stock market participants, plays a role in the EU, supporting the notion that transparency and dissemination of financial information would contribute to the financial soundness of banks. Our data also point to the presence of contagion effects, relatively higher fragility of concentrated banking sectors, and hazards associated with high ratios of wholesale funding.     

Do we need big banks? Evidence on performance,strategy and market discipline

For an international sample of banks, we construct measures of a bank’s absolute size and its systemic size defined as size relative to the national economy. We then examine how a bank’s risk and return on equity, its activity mix and funding strategy, and the extent to which it faces market discipline depend on both size measures. We show that bank returns increase with absolute size, yet decline with systemic size, while neither size measure is associated with bank risk as implicit in the Z-score. These results are consistent with the view that growing to a size that is systemic is not in the interest of bank shareholders. We also find that systemically large banks are subject to greater market discipline as evidenced by a higher sensitivity of their funding costs to risk proxies, consistent with the view that they can become too large to save. A bank’s interest costs, however, are estimated to decline with bank systemic size for all banks apart from those with very low capitalization levels. This suggests that market discipline, exercised through funding costs, does not prevent banks from attaining larger systemic size.     

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.     

Competition,Financial Intermediation,and Riskiness of Banks: Evidence from the Asia-Pacific Region

From a sample of commercial banks in the Asia-Pacific region over the 1994–2009 period, this study highlights that banks in less competitive markets exhibit lower loan growth and higher instability. Such instability is further followed by a decline in deposit growth, suggesting that Asian banks are also subject to indirect market discipline mechanisms through bank competition. This study therefore sheds light on the importance of enhancing bank competition to overcome bank risk and strengthen financial intermediation. Likewise, this study advocates the importance of strengthening market discipline to reduce bank riskiness regardless of the degree of competition in the banking industry.     

Failed bank takeovers and financial stability

Current discussion about the design of bank resolution frameworks suggests that the takeover of a failed bank by an incumbent one has two effects on financial stability. First, the incumbent takeover may boost financial stability by providing bankers with incentives to be solvent so as to profit from their competitors’ failure. Second, the incumbent takeover may spoil financial stability by creating “Systemically Important Financial Institutions”. The innovation of this paper is to capture these two effects in a theoretical model. We show that when incumbent bankers are impatient enough (i.e., they have high discount rates), the second effect prevails over the first one. We discuss the implications of this result for the design of bank resolution policies.     

Firm survival and financial development: Evidence from a panel of emerging Asian economies

Using a panel of five Asian economies - Indonesia, Korea, Malaysia, Singapore and Thailand - over the period 1995-2007 we analyze the links between firm survival and financial development. We find that traditionally used measures of financial development play an important role in influencing firm survival. When stock markets become larger or more liquid firms’ survival chances improve. On the contrary, we show that higher levels of financial intermediation can increase firm failures. We also find that the beneficial effects of stock market development are more pronounced during the later years of our sample, while the adverse effects of bank intermediation have declined over time. Finally, large firms are more likely to benefit from developments in financial markets compared to small firms.     

Are Banks Finally Resolvable? A Perspective from Europe

After the global financial crisis, policymakers in many countries promised that banks should never again be bailed out using taxpayers’ money. Therefore, new regulatory measures were introduced, most importantly new bank resolution regimes like the Single Resolution Mechanism in the euro area. This paper shows that these measures contributed to a reduction in bail-out expectations and a return of market discipline in Europe. But European banks are still far from being truly resolvable. More remains to be done.     

Regulating financial conglomerates

We analyze the risk-taking incentives of a financial conglomerate that combines a bank and a non-bank financial intermediary. The conglomerate's risk-taking incentives depend on the level of market discipline it faces, which in turn is determined by the conglomerate's liability structure. We examine optimal capital regulation for standalone institutions, for integrated conglomerates and holding company conglomerates. We show that, when capital requirements are set optimally, capital arbitrage within holding company conglomerates can raise welfare by increasing market discipline. Because they have a single balance sheet, integrated conglomerates extend the reach of the deposit insurance safety net to their non-bank divisions. We show that the extra risk-taking that this effect causes may wipe out the diversification benefits within integrated conglomerates. We discuss the policy implications of these results.     

Openness,financial structure,and bank risk: International evidence

Using panel data from a large cross-country sample covering 97 countries over the period 1996–2017, we combine 2SLS procedure with system GMM estimation to study the relationship between openness, financial structure and bank risk. The main contribution of the paper is that we identified a new channel, i.e. the financial structure channel, through which financial openness reduces bank risk. In particular, we find that as financial openness increases, a country's financial system tends to be more market-based, and a more market-based financial system is associated with higher bank market power, better information sharing and more revenue diversification, all of which contribute to the reduction in bank risk. We also find that the effect of inflow restrictions on bank risk is more pronounced than that of outflow restrictions. These results highlight the importance of an appropriate design of a country's opening-up strategy to match the evolution of its financial structure to increase bank stability.     

The bright side of market power in Asian banking: Implications of bank capitalization and financial freedom

Using a sample of listed banks in the Asia-Pacific region from 2000 to 2016, this paper documents that higher market power reduces risk taking but increases loan growth and performance in banking. This highlights the "bright side" of bank market power in general. However, the positive effect of market power on bank stability is more pronounced for well-capitalized banks, although their performance tends to decline, and loan growth is unaffected by market power. Hence, bank capitalization plays an important role in strengthening financial stability due to an increase in bank market power. Moreover, banks with higher market power located in countries with a lower degree of financial freedom exhibit lower riskiness, higher loan growth, and better performance. Greater control by authorities in the financial sector is essential, not only to enhance financial stability, but also to boost financial intermediation and bank performance following an increase in bank market power.