The Check's in the Mail: Why the United States Lags in the Adoption of Cost-Saving Electronic Payments

The United States payment system costs around $225 billion annually and checks account for 75% of all noncash payments. Other electronic payment methods (debit cards, automated clearing house direct deposits, and debits) cost only around one third to one half as much as a check. This paper outlines the main reasons why the shift from checks to cheaper electronic payments has been slow, much slower here than in other countries. We also forecast the future use of checks and electronic payments and end by discussing policy initiatives that may speed up this substitution process.     

Market discipline during crisis: Evidence from bank depositors in transition countries

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in a worse financial condition than their subsidiaries. This situation created a unique opportunity to study new aspects of market discipline exercised by non-financial depositors. Using a comprehensive data set, we find that the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. We establish that depositors’ actions were more strongly influenced by negative press rumors concerning parent companies than by fundamentals. The impact of rumors was especially perceptible when rumors turned out ex post to be founded. Additionally, we document that public aid announcements were primarily interpreted by depositors as confirmation of a parent company’s financial distress. Our results indicate that depositors react rationally to sources of information other than financial statements; this discovery has policy implications, as depositor discipline is usually the only viable and universal source of market discipline for banks in emerging economies.     

First Financial Restructuring and operating efficiency: Evidence from Taiwanese commercial banks

This paper investigates the effect of the “First Financial Restructuring” (FFR) on the operating efficiency of commercial banks in Taiwan. Applying data envelopment analysis (DEA) to operations data for 40 commercial banks over the 6-year period 2000–2005, we find that while the banks have lower operating efficiency on average during the reform period (2002–2003) compared to the pre-reform period (2000–2001), improved operating efficiency is reflected in the post-reform period (2004–2005). Our results remain unchanged even after controlling for the non-performing loan ratio, capital adequacy ratio, bank ownership, size, and GDP growth rate. These results suggest that the improved efficiency in the post-reform period is possibly due to enhanced banking and risk management practices and benefits obtained from compliance with the FFR.     

Determinants of bank efficiency during unstable macroeconomic environment: Empirical evidence from Malaysia

The present study investigates for the first time the efficiency of Malaysian banking sector around the Asian financial crisis 1997. The efficiency estimates of individual banks are evaluated by using the Data Envelopment Analysis (DEA) approach. To examine the robustness of the estimated efficiency scores under various alternatives and to differentiate how efficiency scores vary with changes in inputs and outputs, the present study focuses on three major approaches viz., intermediation approach, value added approach, and operating approach. The analysis further links the variation in calculated efficiencies to a set of explanatory variables, i.e. bank size, profitability, and ownership. The empirical findings clearly bring forth the high degree of inefficiency in the Malaysian banking sector, particularly a year after the East Asian crisis. The results suggest that the decline in technical efficiency is more abrupt under the intermediation approach relative to the value added approach and operating approach. The regression results focusing on bank efficiency and other bank specific traits suggest that efficiency is negatively related to expense preference behavior and economic conditions, while bank efficiency is positively related to loans intensity.     

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.     

Small European banks: Benefits from diversification?

Motivated by the liberalisation and harmonisation of financial systems in Europe, we investigate whether the observed shift into non-interest income activities improves performance of small European credit institutions. Using a sample of 755 small banks for the period 1997–2003, we find no direct diversification benefits within and across business lines and an inverse association between non-interest income and bank performance. Our findings are robust to a set of sensitivity analyses using alternative samples and controlling for the regulatory environment. Furthermore, the results provide circumstantial evidence for the presence of economies of scale. The absence of benefits of diversification confirms findings for other banking markets and suggests small European banks enter lines of business where they currently lack expertise and experience. These results have implications for bank supervisors, regulators and bank managers.     

Dynamic debt runs and financial fragility: Evidence from the 2007 ABCP crisis

We use the 2007 asset-backed commercial paper (ABCP) crisis as a laboratory to study the determinants of debt runs. Our model features dilution risk: maturing short-term lenders demand higher yields in compensation for being diluted by future lenders, making runs more likely. The model explains the observed tenfold increase in yield spreads leading to runs and the positive relation between yield spreads and future runs. Results from structural estimation show that runs are very sensitive to leverage, asset values, and asset liquidity, but less sensitive to the degree of maturity mismatch, the strength of guarantees, and asset volatility.     

Market discipline, financial crisis and regulatory changes: Evidence from Indonesian banks

Following the 1997/1998 financial crisis, Indonesian banks experienced major regulatory changes, including the adoption of the blanket guarantee scheme (BGS) in 1998, a limited guarantee (LG) in 2005, and changes in capital regulation in 1998 and 2001. We examine the impact of these regulatory changes on market discipline during the period 1995-2009. The price of deposits is used to measure market discipline in a dynamic panel data methodology on a sample of 104 commercial banks. We find a weakening of market discipline following the introduction of the BGS. The result is consistent with the deposit insurance scheme being credible in the lower capital requirement environment. The adoption of LG in a recovering economy also mitigates the role of market discipline. However, market discipline is more pronounced in listed banks than unlisted banks and in foreign banks than domestic banks. These results have important implications for banking regulation and supervision, particularly during a crisis period.     

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.     

Bank incentives and suboptimal lending decisions: Evidence from the valuation effect of bank loan announcements in Japan

Using a sample of bank loan announcements in Japan, we examine whether or not banks have incentives to engage in suboptimal lending that results in wealth transfer from the banks to the borrowing firms. We find that abnormal returns for borrowing firms are significantly positive, but those for lending banks are sometimes significantly negative. Furthermore, the announcement returns for borrowing firms are negatively related to those for lending banks, especially when poorly performing firms borrow from financially healthy (low-risk) banks. Our results suggest that the positive valuation effect of bank loan announcements for borrowing firms is mainly due to a wealth transfer from lending banks.     

The Effect of Credit Risk on Bank and Bank Holding Company Bond Yields: Evidence from the Post-FDICIA Period

In this article we examine whether the federal safety net is viewed by the market as being extended beyond de jure deposits to other bank debt and even the debt of bank holding companies (BHCs). We extend previous research by focusing on the post‐FDICIA period and by examining the risk‐return relation of bonds issued directly by banks, not BHCs. Our results provide evidence that both bank and BHC bonds are priced by the secondary market in relation to their underlying credit risk, particularly for less capitalized issuers, suggesting that proposals requiring banks to issue subordinated debt may enhance market monitoring and discipline and be useful in supplementing regulatory discipline.     

Bank ownership,privatization, and performance: Evidence from a transition country

This paper combines the static effect of ownership and the dynamic effect of privatization on bank performance in China over 1995–2010, reporting a significantly higher performance by private intermediaries – joint stock commercial banks and city commercial banks – relative to state-owned commercial banks. However, publicly traded banks, subject to multiple monitoring and vetting in capital markets, perform better regardless of ownership status. The privatization of banks has improved performance with respect to revenue inflow and efficiency gains in the short- or long-run (initial public offerings). The positive long-run effect is more relevant and significant for banking institutions with minority foreign ownership. Moreover, this paper innovatively estimates interest income efficiency and non-interest income efficiency at the same time. The results suggest that Chinese banks are much more efficient in generating interest income than raising non-interest revenue, although the latter aspect has improved significantly during the sample period.     

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.     

Reputational contagion and optimal regulatory forbearance

Existing studies suggest that systemic crises may arise because banks either hold correlated assets, or are connected by interbank lending. This paper shows that common regulation is also a conduit for interbank contagion. One bank's failure may undermine confidence in the banking regulator's competence, and, hence, in other banks chartered by the same regulator. As a result, depositors withdraw funds from otherwise unconnected banks. The optimal regulatory response to this behavior can be privately to exhibit forbearance to a failing bank. We show that regulatory transparency improves confidence ex ante but impedes regulators' ability to stem panics ex post.     

Did investors outsource their risk analysis to rating agencies? Evidence from ABS-CDOs

Based on a sample of 3254 floating rate tranches from 617 ABS-CDOs (collateralized debt obligations backed by asset-backed securities), this paper tests the “rating overdependence” hypothesis – i.e., that ratings of structured products are a sufficient statistic (in terms of predicting future credit performance) for yield spreads at origination. The paper’s findings are fourfold. First, yield spreads at issuance predict future performance of ABS-CDO tranches even after controlling for the information contained in ratings. Second, the ability of yield spreads to predict future performance, however, is driven exclusively by ratings below AAA (and, to a lesser extent, also by the lowest priority AAA tranches), whereas spreads of super senior AAA tranches show no information content. Third, the predictive ability of yield spreads is lower for tranches from later vintages and for tranches from deals with more complex collateral pools. Fourth, the conditional correlation between ratings and spreads, in turn, is increasing in time and higher for tranches from complex deals. In sum, the evidence indicates that investors in (especially AAA) tranches from later and more complex deals have avoided performing costly due diligence on the securities they bought.     

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.     

Nominal and true cost of loan collateral

This paper explores costs and proceeds from loan collateral in the credit market with ex-ante asymmetric information when collateral value and the probability of project success fluctuate. A borrower is willing to pledge collateral if (i) its future value is correlated with the probability of project success, or (ii) its value fluctuates strongly, or (iii) it is funded with loan capital. When one of the conditions is satisfied, in contrast to Bester (1985), a high-risk borrower may be more willing to pledge collateral than a low-risk borrower. The paper is related to topical subprime crises and real estate collateral.     

Bank capital regulation in a barrier option framework

The barrier options theory of corporate security valuation is applied to the contingent claims of a regulated bank. The regulator/insurer of a bank owns a down-and-in call option on the bank assets which can be balanced against the expected coverage cost. Raising the regulatory barrier (critical asset level triggering bank closure) leads to a transfer of wealth from stockholders to the insurer and reduces stockholder incentives to increase asset risk. Empirical tests on a sample of 152 one-bank holding companies show that regulatory barriers are priced in the stock market and are inversely related to Tier 1 leverage ratios.     

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.