Banking industry volatility and economic growth

Utilizing the recent dynamic panel GMM estimation techniques for 36 markets, this research investigates the relationship between banking industry volatility and future economic growth, and provides empirical evidence complementary to Cole et al. (2008) who examine the finance-growth nexus from a unique asset pricing theory perspective and document a positive relationship between bank stock returns and future economic growth that is significantly influenced by a series of country-specific and banking institutional characteristics. We find that the negative link between banking industry volatility and future economic growth is significantly affected by government ownership of banks, the enforcement of the insider trading law, systemic banking crises, and bank accounting disclosure standards, while the impact of financial development is ambiguous. The significant results are primarily driven by the data from emerging markets.     

Financial crises and emerging stock markets volatility: do internal factors matter?

This paper has two central aims. The first one is to deal empirically with the effects of financial crises on emerging stock markets volatility. The second objective consists in testing if the level of stock market development affects this relationship. For this purpose, we estimate a static panel data model for a sample of nine emerging economies from January 1990 to December 2006. We consider three types of financial crises, i.e. banking, currency and twin crises. Our empirical results suggest that the onset of financial crises strongly increased stock market volatility. In addition, we find that the biggest impact is exerted by twin crises. When dealing with the second objective, our results show that the market size and the liquidity level can attenuate the effects of banking and currency crises, but not the one associated to twin crises. Nevertheless, the degree of stock market integration seems to reduce the effects of banking, currency and twin crises on stock market volatility.     

Depositors’ Assessment of Bank Riskiness in the Russian Federation

In the period after the crises in the late 1990s, the banking industries in most emerging markets have undergone significant restructuring consistent with the Basel II Accord. The Central Bank of Russia’s efforts since 2000 have contributed to the consolidation and improvement of the banking industry. To measure the extent of market discipline in the Russian banking industry, we study the reaction of Russian depositors to excessive risk taking by large banks between 2000:1 and 2005:1. We find that during our analysis period, well-capitalized, more liquid banks significantly increase their deposits.     

Bank stock returns and economic growth

Previous research has established (i) that a country’s financial sector influence future economic growth and (ii) that stock market index returns affect future economic growth. We extend and tie together these two strands of the growth literature by analyzing the relationship between banking industry stock returns and future economic growth. Using dynamic panel techniques to analyze panel data from 18 developed and 18 emerging markets, we find a positive and significant relationship between bank stock returns and future GDP growth that is independent of the previously documented relationship between market index returns and economic growth. We also find that much of the informational content of bank stock returns is captured by country-specific and institutional characteristics, such as bank-accounting-disclosure standards, banking crises, enforcement of insider trading law and government ownership of banks.     

The Value of Market Information in Banking Supervision: Evidence from Italy

We examine the potential use of signals arising from financial markets as a complement to the information set available to banking supervisors. We provide empirical evidence on Italian banks, using a unique dataset matching accounting ratios, market variables, and supervisory ratings. To verify what type of signal they are able to convey, we analyze the behavior of four equity-based indicators for the Italian banks listed on the Milan stock exchange. We then investigate whether the same indicators provide additional information for supervisors. Econometric results confirm the informative content of market variables and their complementarity with supervisory information.JEL Classification: Bank, banking supervision, early warning, market discipline     

Macroeconomic effects of corporate default crisis: A long-term perspective

Using an extensive data set on corporate bond defaults in the US from 1866 to 2010, we study the macroeconomic effects of bond market crises and contrast them with those resulting from banking crises. During the past 150 years, the US has experienced many severe corporate default crises in which 20–50% of all corporate bonds defaulted. Although the total par amount of corporate bonds has at times rivaled the amount of bank loans outstanding, we find that corporate default crises have far fewer real effects than do banking crises. These results provide empirical support for current theories that emphasize the unique role that banks and the credit and collateral channels play in amplifying macroeconomic shocks.     

Macroeconomic imbalances,financial stress and fiscal vulnerability in the euro area before the debt crises: A market view

This paper tries to identify the macro-financial imbalances that exposed the euro area countries to fiscal stress before the outbreak of the European debt crises. Contrary to conventional wisdom that interprets fiscal stress in terms of fiscal sustainability, we focus on short-term fiscal vulnerability as reflected by the conditions of debt refinancing in the sovereign bond markets. We find that market-based indicators capturing risk perceptions of sovereign debts have been influenced by the indicators defined in the European Macroeconomic Imbalance Procedure (MIP) and by variables of financial vulnerability. When pricing the risk of sovereign bonds, the holders of government debts take into account not only the macroeconomic imbalances but also factors such as banking distress, corporate bond risk, liquidity risks in the interbank market or the volatility of stock prices.     

Bank portfolio exposure to emerging markets and its effects on bank market value

This study estimates a model of banking company equity returns taking into consideration book value and market value measures of their exposure to emerging markets debt. In this estimation, general systematic market factors, such as the rate of return on the S&P500 stock index and yields on a constant maturity 5-year Treasury note, are held constant such that the exposure variables are accounting for effects due to banks’ exposure to emerging market debt. The results, although not uniform among banking companies, support the hypothesis that the extent of exposure to emerging market debt are factored into the valuation of banking company equity contemporaneously. The inclusion of a market value indicator adds to the explanation of equity returns of some banks. It is also clear that knowing the extent of the exposure on a book value basis is important information alone that may allow investors to take account of or evaluate the effects of changes in banking company equity valuation from LDC debt exposures. We also perform an event study for three major debt crises to determine whether the market recognizes the effects of these events on bank valuation. The event study results show that there is little information from identifying the time period of the crises on banking company equity returns. Explanations for this are that the information of these possible crises has been embedded in bank changes in exposure and that the market valuation of the emerging market debt is already accounted for by our model.     

Bank systemic risk and macroeconomic shocks: Canadian and U.S. evidence

This paper investigates how banks, as a group, react to macroeconomic risk and uncertainty; more specifically, it examines the relationship between bank systemic risk and changes and disruptions in economic conditions. Adopting the methodology of Beaudry et al. (2001), we introduce a new estimation procedure based on EGARCH to refine the framework developed by Baum et al., 2002, Baum et al., 2004, Baum et al., 2009 and Quagliariello, 2007, Quagliariello, 2009, and we analyze the relationship in the current industry context—i.e., in the context of market-based banking. Our results confirm that banks tend to behave more homogeneously vis-à-vis macroeconomic uncertainty. In particular, we find that both the cross-sectional dispersion of loans-to-assets and the cross-sectional dispersion of non-interest income share shrink during slow growth episodes, and particularly during financial crises, when the resilience of the banking system is at its lowest. More importantly, our main findings indicate that the cross-sectional dispersion of loans-to-assets has increased in the last decade, whereas the cross-sectional dispersion of non-interest income share appears to be more volatile and sensitive to macroeconomic shocks.     

The market’s view on the probability of banking sector failure: cross-country comparisons

Hall and Miles (1990) suggest an approach of estimating default probabilities of banks using stock market information, and in this paper we apply an aggregated version of their approach to banking sectors around the world in both developed and emerging economies. We study the market’s assessment of the probability of systemic banking crises world wide over the last decade, including the Asian crisis 1997–1998. In addition, we investigate whether there is a relationship between the failure probability and institutional features of the actual banking sector. The quality of governance and the degree of law and order in a country is found to be significantly negatively related to the market based failure probabilities as is an explicit deposit insurance during periods of crisis.     

The Eurozone banking sector in the time of COVID-19: Measuring volatility connectedness

This article investigates the volatility connectedness of the Eurozone banking system over the last 15 years (from 2005 to 2020). Applying the Diebold-Yilmaz Connectedness Index model to the daily stock return volatilities of 30 major Eurozone banks, we are able to measure the risk spillover effects and to capture the COVID-19 outbreak's impact on banking stability. The empirical findings show that the 30 banks are highly interconnected. Furthermore, we show the strong impact of the COVID-19 pandemic on the volatility dynamics, i.e., on the structure of the Eurozone banking system. Dynamically, we find that volatility connectedness increases during crises, reaching its maximum peak at the time of COVID-19. The analysis points out the critical role of volatility transmission played by large banks, highlighting the “too-big-to-fail” characteristic of this banking system. However, we find that small-medium banks are important actors of contagion, supporting the thesis that the Eurozone banking system is also “too-interconnected to fail.” Finally, we document the heterogeneity effect of the COVID-19 pandemic between Eurozone banking systems. This heterogeneity impact could be a future source of financial instability within the Eurozone.     

Bank failures and bank fundamentals: A comparative analysis of Latin America and East Asia during the nineties using bank-level data

This paper uses bank-level data from recent banking crises in East Asia and Latin America to address the following two questions: (1) To what extent did individual bank conditions explain the failures? (2) In terms of their fundamentals, was it mainly the weak banks ex ante that failed in the crisis countries? The results show that for the two regions, bank-level fundamentals significantly affect the likelihood of collapse for these banks. Systemic shocks (both macroeconomic and liquidity) that triggered the crises mainly destabilized the weak banks ex ante, particularly in East Asia, which raises questions about the role that regional differences play for the degree of banking sector resilience to systemic shocks in the financial and macroeconomic environment.     

Intra- and inter-regional return and volatility spillovers across emerging and developed markets: Evidence from stock indices and stock index futures

We provide empirical evidence on the patterns of intra- and inter-regional transmission of information across 10 developed and 11 emerging markets in Asia, the Americas, Europe and Africa using both stock indices and stock index futures. The main transmission channels are examined in the period from 2005 to 2014 through the analysis of return and volatility spillovers around the most recent crises based on the generalized vector autoregressive framework. Our findings demonstrate that markets are more susceptible to domestic and region-specific volatility shocks than to inter-regional contagion. A novel result reported in our study is a difference in patterns of international signals transmission between models employing indices and futures data. We conclude that futures data provide more efficient channels of information transmission because the magnitude of return and volatility spillovers across futures is larger than across indices. Our findings are relevant to practitioners, such as stock market investors, as well as policy makers and can help enhance their understanding of financial markets interconnectedness.     

Financial markets development,business cycles,and bank risk in South America

In this paper, we examine whether banking crises or business cycles affect the influence of financial markets development on bank risk in a sample of 37 publicly listed commercial banks in seven South American countries over a 22-year period between 1991 and 2012. Banking crises in this region offer a natural setting in which the impact of financial markets development on bank risk is examined. We find that financial markets development improves banks’ capitalization ratio and reduces their exposure to non-traditional banking activities, suggesting that financial markets development on average reduces bank risk. In addition, banking crises and business cycles appear to moderate the impact of financial markets development on bank risk. In the aftermath of banking crises, banks appear to concentrate more on their core traditional banking activities.     

Bank size, market concentration, and bank earnings volatility in the US

We examine whether bank earnings volatility depends on bank size and the degree of concentration in the banking sector. Using quarterly data for non-investment banks in the United States for the period 2004Q1-2009Q4 and controlling for the quality of management, leverage, and diversification, we find that bank size reduces return volatility. The negative impact of bank size on bank earnings volatility decreases (in absolute terms) with market concentration. We also find that larger banks located in concentrated markets have experienced higher volatility during the recent financial crisis.     

US macroeconomic news effects around the US and European financial crises: Evidence from Brazilian and Mexican equity indices

We examine the intraday index return and volatility responses of two Latin American equity markets to US macroeconomic news releases around the periods of the US and European financial crises. We find that while index return is more sensitive than volatility to macroeconomic news in general, the five-minute Brazilian and Mexican index volatilities respond especially strongly to US news surprises, with the Brazilian response being more pronounced, especially during the expansion period. Among the macroeconomic indicators tested, FOMC rate decisions exhibit the highest impact on volatility, and there is evidence of asymmetric response to positive versus negative news.     

Stock market integration between the UK and the US: Evidence over eight decades

This study investigates how the impact made on stock market integration by macroeconomic determinants such as various measures of convergence and financial volatility, as well as crisis episodes, varies over the period 1935–2015. We gauge how the level of integration between the UK and US stock markets changes across three monetary regimes during this period: pre–Bretton Woods (BW), the BW fixed exchange rate, and the post-BW flexible rates. Our empirical results suggest that integration was strongest under the post-BW regime and weakest under the BW regime. We further demonstrate that stock market integration between the two markets has been driven largely by macroeconomic convergence and financial volatility as well as by crises, especially since the demise of the BW system.     

Explaining banking stability in Sub-Saharan Africa

The study examined banking stability in Sub-Saharan Africa. The results reveal that banking spread (Net Interest Margin – NIM) is the main determinant of stability and the major means to achieve stability during crises periods. We however find the existence of a threshold effect in NIM.Crises in the banking sector consistently showed to reduce stability. While the results show that high percentage of foreign banks reduce stability, we find foreign banks help stabilize the banking sector in periods of crises. The results show that diversification could also have a positive impact on stability (Z-score) even though this relationship was not robust enough. The results also largely support the competition-fragility view. Particularly, we find that less competition during crises periods can help improve stability. Again, we find evidence for both concentration-stability and concentration-fragility hypotheses depending on the stability measure used. We however find that when large banks in concentrated markets are well regulated, stability could be improved. Weak regulatory environment reduces stability (Z-score) directly and matters during crises periods. Our results are robust to the use of different indicators of stability and estimation methods.     

Local and spillover shocks in implied market volatility: evidence for the U.S. and Germany

The occurrence and the transmission of large shocks in international equity markets is of essential interest to the study of market integration and financial crises. To this aim, implied market volatility allows to monitor ex ante risk expectations in different markets. We investigate the behavior of implied market volatility indices for the U.S. and Germany under a straightforward mean reversion model that allows for Poisson jumps. Our empirical findings for daily data in the period 1992 to 2002 provide evidence of significant positive jumps, i.e. situations of market stress with positive unexpected changes in ex ante risk assessments. Jump events are mostly country-specific with some evidence of volatility spillover. Analysis of public information around jump dates indicates two basic categories of events. First, crisis events occurring under spillover shocks. Second, information release events which include three subcategories, namely—worries about as well as actual—unexpected releases concerning U.S. monetary policy, macroeconomic data and corporate profits. Additionally, foreign exchange market movements may cause volatility shocks.     

Bank recapitalization and economic recovery after financial crises

Does support to distressed banks early on during financial crises mitigate the macroeconomic consequences of financial distress, and if so does it matter what form the intervention takes? We analyze the effects of government and central bank interventions in 69 systemic banking crises since 1980, of which 29 are part of the recent global financial crisis. Our estimation approach controls for the correlation between intervention measures and the time-invariant component of unobservable crisis severity. We find that timely bank recapitalizations substantially reduce the duration of recessions, underscoring the distortions caused by zombie banks and the costs of regulatory forbearance.