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.     

The diversification and financial performance of US credit unions

For US credit unions, revenue from non-interest sources has increased significantly in recent years. We investigate the impact of revenue diversification on financial performance for the period 1993–2004. The impact of a change in strategy that alters the share of non-interest income is decomposed into a direct exposure effect, reflecting the difference between interest and non-interest bearing activities, and an indirect exposure effect which reflects the effect of the institution’s own degree of diversification. On both risk-adjusted and unadjusted returns measures, a positive direct exposure effect is outweighed by a negative indirect exposure effect for all but the largest credit unions. This may imply that similar diversification strategies are not appropriate for large and small credit unions. Small credit unions should eschew diversification and continue to operate as simple savings and loan institutions, while large credit unions should be encouraged to exploit new product opportunities around their core expertise.     

Safety-net benefits conferred on difficult-to-fail-and-unwind banks in the US and EU before and during the great recession

This paper investigates the links between regulatory arbitrage, financial instability, and taxpayer loss exposures. We model and estimate ex ante safety-net benefits from increased leverage and asset volatility at a sample of large banks in US and Europe during 2003–2008. Hypothesis tests indicate that, in both crisis and precrisis years, difficult-to-fail-and-unwind (DFU) banks enjoyed substantially higher ex ante benefits than other institutions. Compared to the US sample, safety-net benefits prove significantly larger for DFU firms in Europe and bailout decisions are less driven by asset size. Introducing a proxy for differences in government susceptibility to regulatory capture helps to explain bailout decisions in Europe. Our findings suggest that authorities in both venues could better contain safety-net benefits if they refocused their information systems on monitoring volatility as well as capital.     

Bank regulatory capital and liquidity: Evidence from US and European publicly traded banks

The theory of financial intermediation highlights various channels through which capital and liquidity are interrelated. Using a simultaneous equations framework, we investigate the relationship between bank regulatory capital and bank liquidity measured from on-balance sheet positions for European and US publicly traded commercial banks. Previous research studying the determinants of bank capital buffer has neglected the role of liquidity. On the whole, we find that banks decrease their regulatory capital ratios when they face higher illiquidity as defined in the Basel III accords or when they create more liquidity as measured by Berger and Bouwman (2009). However, considering other measures of illiquidity that focus more closely on core deposits in the United States, our results show that small banks strengthen their solvency standards when they are exposed to higher illiquidity. Our empirical investigation supports the need to implement minimum liquidity ratios concomitant to capital ratios, as stressed by the Basel Committee; however, our findings also shed light on the need to further clarify how to define and measure illiquidity and also on how to regulate large banking institutions, which behave differently than smaller ones.     

The performance of banks around the receipt and repayment of TARP funds: Over-achievers versus under-achievers

In this paper, we look at how the pre-crisis health of banks is related to the probability of receiving and repaying TARP capital. We find that financial performance characteristics that are related to the probability of receiving TARP funds differ for the healthiest (“over-achiever”) versus the least healthy (“under-achiever”) banks. We find that TARP under-achievers have some, but not consistent, weaknesses in income production. These banks also are experiencing liquidity issues as customers, shut out of public debt markets, get bank loans through drawdowns of loan commitments. Unlike TARP under-achievers, TARP over-achievers’ loans are performing well. Yet, liquidity issues (from low levels of liquid assets and core deposits and drawdowns of loan commitments) hurt the abilities of these banks to continue their lending. Differences between under-achiever and over-achiever banks are also found for repayment and deadbeat TARP banks.     

The effects of focus versus diversification on bank performance: Evidence from Chinese banks

This paper investigates the effects of focus versus diversification on bank performance using data on Chinese banks during the 1996–2006 period. We construct a new measure, economies of diversification, and compare the results to those of the more conventional focus indices, which are based on the sum of squares of shares in different products or regions. Diversification is captured in four dimensions: loans, deposits, assets, and geography. We find that all four dimensions of diversification are associated with reduced profits and higher costs. These results are robust regardless of alternative measures of diversification and performance. Furthermore, we observe that banks with foreign ownership (both majority and minority ownership) and banks with conglomerate affiliation are associated with fewer diseconomies of diversification, suggesting that foreign ownership and conglomerate affiliation may play important mitigating roles. This analysis may provide important implications for bank managers and regulators in China as well as in other emerging economies.     

Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects

This paper examines the broader effects of the US financial crisis on global lending to retail customers. In particular we examine retail bank lending in Germany using a unique data set of German savings banks during the period 2006 through 2008 for which we have the universe of loan applications and loans granted. Our experimental setting allows us to distinguish between savings banks affected by the US financial crisis through their holdings in Landesbanken with substantial subprime exposure and unaffected savings banks. The data enable us to distinguish between demand and supply side effects of bank lending and find that the US financial crisis induced a contraction in the supply of retail lending in Germany. While demand for loans goes down, it is not substantially different for the affected and nonaffected banks. More important, we find evidence of a significant supply side effect in that the affected banks reject substantially more loan applications than nonaffected banks. This result is particularly strong for smaller and more liquidity-constrained banks as well as for mortgage as compared with consumer loans. We also find that bank-depositor relationships help mitigate these supply side effects.     

How the Internet affects output and performance at community banks

Internet web sites have become an important alternative distribution channel for most banking institutions. However, we still know little about the impact of this delivery channel on bank performance. We observe 424 community banks among the first wave of US banks to adopt transactional banking web sites in the late-1990s, and compare the change in their 1999–2001 financial performance to that of 5175 branching-only community banks. Whereas today virtually all viable community banking franchises offer the Internet banking channel, studying this earlier time period allows us to make clean comparisons between subsamples of “brick-and-mortar” and “click-and-mortar” community banks. We find that Internet adoption improved community bank profitability, chiefly through increased revenues from deposit service charges. Internet adoption was also associated with movements of deposits from checking accounts to money market deposit accounts, increased use of brokered deposits, and higher average wage rates for bank employees. We find little evidence of changes in loan portfolio mix. Our findings suggest that these initial click-and-mortar banks (and their customers) used the Internet channel as a complement to, rather than a substitute for, physical branches.     

The impact of off-balance-sheet activities on banks returns: An application of the ARCH-M to Canadian data

This paper revisits the impact of off-balance-sheet (OBS) activities on banks risk-return trade-off. Recent studies (e.g., Stiroh and Rumble, 2006) show that increasing OBS activities does not necessarily yield straightforward diversification benefits for banks. However, introducing a risk premium in the standard banks returns models, and resorting to an ARCH-M procedure, Canadian data suggest that banks risk-return trade-off displays a structural break around 1997. In the second subperiod of our sample (1997–2007), we find that the noninterest income generated by OBS activities no longer impacts banks returns negatively. While during the first period (1988–1996) the volatility variable is not significant in any returns equations, a risk premium eventually emerges, pricing the risk associated to OBS activities.     

Is the Internet delivery channel changing banks’ performance? The case of Spanish banks

In spite of the conspicuous use of the Internet as a delivery channel, there is a relative dearth of empirical studies that provide a quantitative analysis of the impact of the Internet on banks’ financial performance. This paper attempts to fill this gap by identifying and estimating the impact of the adoption of a transactional web site on financial performance using a sample of 72 commercial banks operating in Spain over the period 1994–2002. The impact on banks’ performance of transactional web adoption takes time to appear. The adoption of the Internet as a delivery channel involves a gradual reduction in overhead expenses (particularly, staff, marketing and IT). This effect is statistically significant after one and a half years after adoption. The cost reduction translates into an improvement in banks’ profitability, which becomes significant after one and a half years in terms of ROA and after three years in terms of ROE. The paper also concludes that the Internet is being used as a complement to, rather than a substitute for, physical branches.     

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.     

Loan growth and riskiness of banks

We investigate whether loan growth affects the riskiness of individual banks in 16 major countries. Using Bankscope data from more than 16,000 individual banks during 1997–2007, we test three hypotheses on the relation between abnormal loan growth and asset risk, bank profitability, and bank solvency. We find that loan growth leads to an increase in loan loss provisions during the subsequent three years, to a decrease in relative interest income, and to lower capital ratios. Further analyses show that loan growth also has a negative impact on the risk-adjusted interest income. These results suggest that loan growth represents an important driver of the riskiness of banks.     

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 effects of big-bank presence on the profit efficiency of small banks in rural markets

Because big banks could impact competition in rural markets, we investigate the effects of big-bank presence on the performance of rural, small banks. When competing against a big bank, rural one-county banks operate at lower levels of proit efficiency, but with higher ROA and increased levels of interest and fee income from loans. Lower profit efficiency and higher returns in the rural markets suggest that big banks possess market power in rural markets and that they can extract rents to earn higher returns with lower than average profit efficiency. Therefore, small banks in rural markets should not fear large competitors. Conversely, customers who rely on loans from rural, small banks are negatively impacted by higher rates and fees on loans when a big bank is present in the market.     

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.     

What explains the low profitability of Chinese banks?

This paper analyzes empirically what explains the low profitability of Chinese banks for the period 1997–2004. We find that better capitalized banks tend to be more profitable. The same is true for banks with a relatively larger share of deposits and for more X-efficient banks. In addition, a less concentrated banking system increases bank profitability, which basically reflects that the four state-owned commercial banks – China’s largest banks – have been the main drag for system’s profitability. We find the same negative influence for China’s development banks (so-called Policy Banks), which are fully state-owned. Instead, more market-oriented banks, such as joint-stock commercial banks, tend to be more profitable, which again points to the influence of government intervention in explaining bank performance in China. These findings should not come as a surprise for a banking system which has long been functioning as a mechanism for transferring huge savings to meet public policy goals.     

Commitment, banks and markets

We examine how banks and financial markets interact with one another to provide liquidity to investors. The critical assumption is that financial markets are characterized by limited enforcement of contracts, and in the event of default only a fraction of borrowers’ assets can be seized. Limited enforcement reduces the fraction of assets that can be used as collateral and thus individuals subject to liquidity shocks face borrowing constraints. We show how banks endogenously overcome these borrowing constraints by pooling resources across several depositors, and increase the liquidity provided by financial markets.     

Financial dollarization: The role of foreign-owned banks and interest rates

Why in many economies households and firms borrow and make deposits in foreign currency? Expanding on the existing literature, our framework addresses this question allowing for interest rate differentials and access to foreign funds to play a role in explaining this process of asset substitution or financial dollarization. Using a newly compiled data set on transition economies and employing a standard panel as well as a panel-VAR methodology we find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits.     

The price-setting behavior of banks: An analysis of open-end leverage certificates on the German market

This paper presents the first analysis of open-end leverage certificates on the German market. The major innovations of these certificates are twofold. First, issuers announce a price-setting formula according to which they are willing to buy and sell the certificates over time. Second, the product’s lifetime is potentially endless. Our main findings are that the price-setting formula is (i) designed to strongly favor the issuer and (ii) is consistent with the main outcome of the ‘life cycle hypothesis’ for structured financial products [Stoimenov, P.A., Wilkens, S., 2005. Are structured products ‘fairly’ priced? An analysis of the German market for equity-linked instruments. Journal of Banking and Finance 29, 2971–2993]. (iii) This holds for different product features and also in the presence of issuers’ credit risk and jump risk in the underlying.     

Performance and Merton-type default risk of listed banks in the EU: A panel VAR approach

This paper provides empirical evidence that sheds new light into the dynamic interactions between risk and efficiency, a highly debated issue. First, we estimate three alternative measures of bank performance, by employing a directional distance function framework, along with a cost frontier and a profit function. As a second step, we calculate a Merton-type bank default risk. Then, we employ a panel VAR analysis, which allows the examination of the underlying relationships between efficiency and risk without applying any a priori restrictions. Most evidence shows that the effect of a one standard deviation shock of the distance to default on inefficiency is negative and substantial. There is some evidence of a reverse causation. As part of a sensitivity analysis, we extent our study to investigate the relationship between efficiency and default risk for banks with different types of ownership structures and across financial systems with different levels of development.