Bank Earnings Management and Tail Risk during the Financial Crisis

We show that a pattern of earnings management in bank financial statements has little bearing on downside risk during quiet periods, but seems to have a big impact during a financial crisis. Banks demonstrating more aggressive earnings management prior to 2007 exhibit substantially higher stock market risk once the financial crisis begins as measured by the incidence of large weekly stock price “crashes” as well as by the pattern of full‐year returns. Stock price crashes also predict future deterioration in operating performance. Bank regulators may therefore interpret them as early warning signs of impending problems.     

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.     

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.     

Financial Crises and Recapitalizations

We develop a dynamic stochastic general equilibrium model with financial frictions on both financial intermediaries and goods‐producing firms. Since financial intermediaries are highly leveraged, we show that the welfare gains from their recapitalization in response to large but rare net worth losses are as large as those from eliminating typical business cycle fluctuations. We also find that these gains are increasing in the size of the net worth loss, are larger when recapitalization funds are raised from the household rather than the real sector, and can be larger when lower idiosyncratic risk leads to higher leverage.     

Financial Turmoil, Failed Bank Acquisitions, and Bank Business Lending Behavior

This paper utilizes bank Call Report and FDIC receivership data from 1987 to 1991 to examine the impact of a failed bank acquisition on the growth rate of commercial and industrial (C&I) lending at the acquiring institutions. Using a two-stage least squares model with fixed effects, we find that banks acquiring a failed bank's assets experience a significant decline in both the growth rate of C&I lending and their capital asset ratios in the period of the acquisition. The results support anecdotal evidence that failed-bank borrowers may experience difficulties in accessing credit once their bank fails and underscores the importance of bank-borrower relationships in C&I lending. Finally, the paper provides an alternative explanation for banks' stagnant or declining business lending activity during this period of financial turmoil.     

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.     

A note on foreign bank ownership and monitoring: An international comparison

This paper empirically analyzes the relation between foreign bank ownership and the three pillars of the New Basel Capital Accord (i.e., capital regulatory oversight, supervisory oversight, and market discipline). Using a new database covering 153 countries, we find that countries with greater market discipline have a lower presence of foreign banks operating in their economy. Furthermore, our evidence indicates that capital regulatory oversight and supervisory oversight are not significantly related to foreign bank ownership.     

Foreign Banks: Trends and Impact

Over the past two decades, foreign banks have become much more important in domestic financial intermediation, heightening the need to understand their behavior. We introduce a new, comprehensive database, made publicly available, on bank ownership (including the home country of foreign banks) for 5,324 banks in 137 countries over the period 1995–2009. We document large increases in foreign bank presence in many countries, but with substantial heterogeneity in terms of host and banks’ home countries, bilateral investment patterns, and bank characteristics. In terms of impact, we document that the relation between private credit and foreign bank presence importantly depends on host country and banks’ characteristics. Specifically, foreign banks only seem to have a negative impact on credit in low‐income countries, in countries where they have a limited market share, where enforcing contracts is costly and where credit information is limited available, and when they come from distant home countries. This shows that accounting for heterogeneity, including bilateral ownership, is crucial to better understand the implications of foreign bank ownership.     

The Impact of the 2007 Liquidity Shock on Bank Jumbo Mortgage Lending

This paper explores the consequences of the collapse of the private‐label residential mortgage‐backed securities market in 2007 on banks’ originations of jumbo mortgages. We show that jumbo lending declined by more at banks that were more dependent on this market and were less well capitalized. In contrast, banks that had little dependence on this market and were well capitalized increased jumbo originations. These findings highlight how dependence on the secondary market may cause amplification of financial shocks, and the potential value of capital requirements that are higher during periods of economic growth in mitigating the amplification effects.     

On the importance of indirect banking vulnerabilities in the Eurozone

This paper investigates banking and sovereign distress in the Eurozone and the importance of direct and indirect financial exposures. We use BIS cross-border banking claims to link member states in a GVAR framework and jointly model sectoral CDS premia. Based on balance sheet positions of an intermediate debtor country, we calculate indirect exposures and asses how the level of interconnectedness is impacted when indirect links are accounted for. We notice a general slowdown in financial integration and a reduction in cross-border assets in the hope of limiting international contagion. By differentiating between direct and indirect links, we show that the impact of reduced weights on core member states is mostly insignificant and that deleveraging strategies are not generally able to successfully reduce risk.     

Bank lending during the financial crisis of 2008

This paper shows that new loans to large borrowers fell by 47% during the peak period of the financial crisis (fourth quarter of 2008) relative to the prior quarter and by 79% relative to the peak of the credit boom (second quarter of 2007). New lending for real investment (such as working capital and capital expenditures) fell by only 14% in the last quarter of 2008, but contracted nearly as much as new lending for restructuring (LBOs, M&As, share repurchases) relative to the peak of the credit boom. After the failure of Lehman Brothers in September 2008, there was a run by short-term bank creditors, making it difficult for banks to roll over their short term debt. We find that there was a simultaneous run by borrowers who drew down their credit lines, leading to a spike in commercial and industrial loans reported on bank balance sheets. We examine whether these two stresses on bank liquidity led them to cut lending. In particular, we show that banks cut their lending less if they had better access to deposit financing and thus, they were not as reliant on short-term debt. We also show that banks that were more vulnerable to credit-line drawdowns because they co-syndicated more of their credit lines with Lehman Brothers reduced their lending to a greater extent.     

Bank Heterogeneity and Interest Rate Setting: What Lessons Have We Learned since Lehman Brothers?

A substantial literature has investigated the role of relationship lending in shielding borrowers from idiosyncratic shocks. Much less is known about how lending relationships and bank‐specific characteristics affect the functioning of the credit market in an economy‐wide crisis. We investigate how bank and bank–firm relationship characteristics have influenced interest rate setting since the collapse of Lehman Brothers. We find that interest rate spreads increased by less for those borrowers having closer lending relationships. Furthermore, firms borrowing from banks endowed with large capital and liquidity buffers and from banks engaged mainly in traditional lending were kept more insulated from the financial crisis.     

Interenterprise Credit and Adjustment during Financial Crises: The Role of Firm Size

Small and medium‐sized enterprises (SMEs) suffered a sharp contraction in their borrowing from banks during the Great Recession. Analyzing a large firm‐level database for European countries, the paper shows that trade credit amplified the liquidity squeeze on SMEs, with adverse effects on their real activity. SMEs sharply increased their net trade credit and thus transferred financial resources to larger firms. Given the large weight of SMEs in the economy of European countries, the liquidity squeeze of SMEs likely contributed to the depth of the output fall and the slow recovery in Europe during the Great Recession.     

Bank Relationship and Firm Performance: Evidence From Thailand Before the Asian Financial Crisis

Abstract:   This study examines the relation between bank relations and market performance in Thailand, an economy in which commercial banks play a crucial role through lending relationship and, for a number of companies, equity ownership. Overall, bank relationships, both equity‐based and debt‐based, positively affect capital investment. However, there is a negative relation between lending relationships, both short‐term and long‐term, and market performance indicating that bank lending may not always be consistent with value maximization. There is also evidence of a positive marginal effect of bank monitoring through equity ownership on market performance. Further, the relation between bank equity ownership and market performance appears to be non‐linear with a concave function. Ownership by corporate insiders is also negatively related to bank equity ownership. Overall, the findings highlight the detrimental effects of excessive short‐term debt usage, one of the factors believed to contribute to the financial crisis in Thailand, and the marginal benefit of the equity‐based relationship on firm value.     

The flight home effect: Evidence from the syndicated loan market during financial crises

This paper shows that the collapse of the global market for syndicated loans during financial crises can in part be explained by a flight home effect whereby lenders rebalance their loan portfolios in favor of domestic borrowers. The home bias of lenders' loan origination increases by approximately 20% if the bank's home country experiences a banking crisis. This flight home effect is distinct from flight to quality because borrowers of different quality are equally affected. The results indicate that the home bias in capital allocation tends to increase when adverse economic shocks reduce the wealth of international investors.     

影子银行与金融危机

本文认为,此次全球金融危机的根源在于回购市场挤提引起的银行恐慌。机构投资者是回购市场的需求者,他们向影子银行"存款",影子银行则以资产抵押支持证券保证"存款"的安全。当证券化资产的折价率大幅提高时,就出现了回购市场挤提,引起银行恐慌,从而导致了此次全球金融危机。     

Foreign banks in syndicated loan markets

Foreign banks play a prominent role in syndicated loan markets. In this paper we examine foreign banks’ motives in participating in cross-border deals in 25 European countries. We find that usual explanations of foreign banking activities can only account partly for the high rate of foreign involvement in syndicated loan markets. The usual argument is that foreign banks are at a disadvantage because they lack soft information and thus they tend to lend to more transparent firms compared to their domestic counterparts. We find that this relationship only holds in relatively small financial systems. We illustrate different motivations for the large amount of cross border lending in large developed markets. In these markets foreign banks tend to lend to especially risky borrowers and projects.     

How Accurately Can Z‐score Predict Bank Failure?

Bank risk is not directly observable, so empirical research relies on indirect measures. We evaluate how well Z‐score, the widely used accounting‐based measure of bank distance to default, can predict bank failure. Using the U.S. commercial banks’ data from 2004 to 2012, we find that on average, Z‐score can predict 76% of bank failure, and additional set of other bank‐ and macro‐level variables do not increase this predictability level. We also find that the prediction power of Z‐score to predict bank default remains stable within the three‐year forward window.