Depositor Behavior under Macroeconomic Risk: Evidence from Bank Runs in Emerging Economies

Depositor behavior has been associated with bank‐specific characteristics, random runs, or contagion episodes. Using evidence on the 2000–02 bank runs in Argentina and Uruguay, this paper shows that macroeconomic risk is also important. Few macroeconomic shocks can quickly cause large runs. Macroeconomic risk affects deposits regardless of traditional bank‐specific characteristics. Furthermore, bank exposure to macroeconomic factors can explain differences in deposit withdrawals. During crises, the evolution of bank‐specific characteristics is mainly driven by macroeconomic factors, while the informational content of bank‐specific variables declines. Overall, depositors seem responsive to risk in a broader sense than that often considered by the literature.     

Macroeconomic Factors and Microlevel Bank Behavior

We analyze the link between banks and the macroeconomy using a model that extends a macroeconomic VAR for the U.S. with a set of factors summarizing conditions in about 1,500 commercial banks. We investigate how macroeconomic shocks are transmitted to individual banks and obtain the following main findings. Backward‐looking risk of a representative bank declines, and bank lending increases following expansionary shocks. Forward‐looking risk increases following an expansionary monetary policy shock. There is, however, substantial heterogeneity in the transmission of macroeconomic shocks, which is due to bank size, capitalization, liquidity, risk, and the exposure to real estate and consumer loans.     

Competition versus efficiency: What drives franchise values in European banking?

This paper investigates how stock market investors perceive the impact of market structure and efficiency on the long-run performance potential of European banks. To that end, a modified Tobin’s Q ratio is introduced as a measure of bank franchise value. This measure is applied to discriminate between the market structure and efficient-structure hypotheses in a coherent forward-looking framework, in which differences in banks’ horizontal and vertical differentiation strategies are controlled for. The results show that banks with better management or production technologies possess a long-run competitive advantage. In addition, bank market concentration does not affect all banks equally. Only the banks with a large market share in a concentrated market are able to generate non-competitive rents. The paper further documents that the forward-looking, long-run perspective and the noise-adjustment of the performance measure overcome most of the drawbacks associated with testing these hypotheses in a multi-country set-up. Finally, notwithstanding the international expansion of bank activities, the harmonization of regulation and the macroeconomic convergence in the European Union (EU15), we still find that country-specific macroeconomic variables have a significant impact on bank performance. The findings indicate that there is a trade-off between competition and stability that should be taken into account when assessing mergers or acquisitions.     

Shadow Banks and Macroeconomic Instability

We develop a macroeconomic model in which commercial banks can offload risky loans to a “shadow” banking sector, and financial intermediaries trade in securitized assets. The model can account both for the business cycle comovement between output, traditional bank, and shadow bank credit, and for the behavior of macroeconomic variables in a liquidity crisis centered on shadow banks. We find that following a liquidity shock, stabilization policy aimed solely at the market in securitized assets is relatively ineffective.     

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.     

U.S. Banking Sector Operational Losses and the Macroeconomic Environment

Using supervisory data from large U.S. bank holding companies (BHCs), we find that BHCs incur more operational losses in adverse macroeconomic conditions driven significantly by the higher frequency and severity of tail events. Among different operational risk types, we find that losses from BHCs' failure to meet obligations to clients or from the design of their products are particularly countercyclical. We also show that larger and more leveraged BHCs have a higher macroeconomic sensitivity of operational risk. Overall, our findings provide new evidence regarding U.S. banking organizations' exposure to macroeconomic shocks with implications for risk management practices and supervisory policy.     

Cash holdings in private firms

Evidence from a wide sample of Italian private firms shows that cash holdings are significantly related with smaller size, higher risk and lower effective tax rates, therefore supporting predictions from the trade-off model. More cash is also held by firms with longer cash conversion cycles and lower financing deficits, as predicted by the financing hierarchy theory. Reported evidence also shows that dividend payments are associated with more cash holdings, and both bank debt and net working capital represent good cash-substitutes. When controlling for macroeconomic and industry factors, some variables lose their significance, but the general findings are confirmed. Finally, cash-rich companies are found to be more profitable, to pay more dividends and to invest more in a medium-term future horizon.     

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.     

The impact of sovereign rating actions on bank ratings in emerging markets

This paper analyses the effects of sovereign rating actions on the credit ratings of banks in emerging markets, using a sample from three global rating agencies across 54 countries for 1999–2009. Despite widespread attention to sovereign ratings and bank ratings, no previous study has investigated the link in this manner. We find that sovereign rating upgrades (downgrades) have strong effects on bank rating upgrades (downgrades). The impact of sovereign watch status on bank rating actions is much weaker and often insignificant. The sensitivity of banks’ ratings to sovereign rating actions is affected by the countries’ economic and financial freedom and by macroeconomic conditions. Ratings of banks with different ownership structures are all influenced strongly by the sovereign rating, with some variation depending on the countries’ characteristics. Emerging market bank ratings are less likely to follow sovereign rating downgrades during the recent financial crisis period.     

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 risks and characteristic-based factor models

We show that book-to-market, size, and momentum capture cross-sectional variation in exposures to a broad set of macroeconomic factors identified in the prior literature as potentially important for pricing equities. The factors considered include innovations in economic growth expectations, inflation, the aggregate survival probability, the term structure of interest rates, and the exchange rate. Factor mimicking portfolios constructed on the basis of book-to-market, size, and momentum therefore, serve as proxy composite macroeconomic risk factors. Conditional and unconditional cross-sectional asset pricing tests indicate that most of the macroeconomic factors considered are priced. The performance of an asset pricing model based on the macroeconomic factors is comparable to the performance of the Fama and French (1993) model. However, the momentum factor is found to contain incremental information for asset pricing.     

Are foreign banks more profitable than domestic banks? Home- and host-country effects of banking market structure, governance, and supervision

Using both bank- and country-level data on banking sectors from 70 countries over the period 1992-2006, this paper empirically investigates the joint home- and host-country effects of banking market structure, macroeconomic condition, governance, and changes in bank supervision on foreign bank margins. We find that foreign banks are more profitable than domestic banks when they operate in a host country whose banking sector is less competitive and when the parent bank in the home country is highly profitable. Moreover, when foreign banks operate in a host country with lower growth rates of GDP, higher interest and inflation rates, and more stringent regulatory compliance with Basel risk weights, their margins increase. Specifically, changes in bank supervision of a parent bank’s ownership restrictiveness in the home country significantly increases foreign bank margins, while supervisory changes in regulatory compliance with Basel risk weights in the host country enhances foreign bank margins.     

Federal Home Loan Bank Advances and Commercial Bank Portfolio Composition

Federal Home Loan Bank (FHLB) advances are a source of government‐sponsored liquidity intended to encourage housing finance, although “community financial institutions” may use such funds more generally. Because money is fungible, it is an empirical question as to how advances are actually employed. Using panel‐vector autoregression techniques, we estimate dynamic responses of U.S. commercial bank portfolios to: FHLB advance shocks, bank lending shocks, and macroeconomic shocks. We find that FHLB advances: (i) are used as a general source of liquidity by U.S. commercial banks of all sizes and (ii) dampen the sensitivity of mortgage lending to macroeconomic shocks at small banks.     

The impact of banking sector reform in a transition economy: Evidence from Kyrgyzstan

We examine the impact of financial sector reform on interest rate levels and spreads using Kyrgyz bank-level data from 1998 to 2005. We find that, in addition to macroeconomic stabilization, structural reforms to the banking sector significantly contributed to lower interest rates. In particular, our results suggest that foreign bank entry and regulatory efforts to increase average bank size were important in reducing deposit rates. In contrast, we find little evidence that banking sector reform or macroeconomic stabilization has impacted interest rate spreads.     

The determinants of shareholder value in European banking

This paper examines the determinants of shareholder value creation for a large sample of European banks between 1998 and 2005. As the recent turmoil in global banking systems has illustrated, bank performance can have a substantial influence on efficient capital allocation, company growth and economic development. We use a dynamic panel data model where the bank’s shareholder value is a linear function of various bank-specific, industry-specific and macroeconomic variables. We show that shareholder value has a positive relationship with cost efficiency changes, while economic profits are linked to revenue efficiency changes. Credit losses, market and liquidity risk and leverage are also found to substantially influence bank performance. These results are robust to a variety of different model specifications.     

Credit Traps and Macroprudential Leverage

We construct a macroeconomic model with overlapping generations to study credit traps—prolonged periods of stagnant real activity accompanied by low productivity, financial sector undercapitalization, and credit misallocation. Shocks to bank capital tighten banks' borrowing constraints causing them to allocate credit to easily collateralizable but low productivity projects. Low productivity weakens bank capital generation, reinforcing tight borrowing constraints, sustaining the credit trap steady state. Macroprudential policy to limit bank leverage can be welfare enhancing. In the presence of a credit trap, optimal leverage policy is countercyclical.     

Supervisors as information producers: Do stress tests reduce bank opaqueness?

Supervisory stress tests assess the impact of an adverse macroeconomic scenario on the profitability and capitalisation of a large number of banks. The results of such stress test exercises have recently been disclosed to the public in an attempt to restore confidence and to curb bank opaqueness by helping investors distinguish between sound and fragile institutions. In an unprecedented effort for transparency, the 2011 European Union stress test lead to the release of some 3400 data points for each of the 90 participating banks. This makes it an ideal setting to investigate a number of hypotheses on the information role of the stress tests.     

Bank panics and the endogeneity of central banking

Central banking is intimately related to liquidity provision to banks during times of crisis, the lender-of-last-resort function. This activity arose endogenously in certain banking systems. Depositors lack full information about the value of bank assets, so that during macroeconomic downturns they monitor their banks by withdrawing in a banking panic. The likelihood of panics depends on the industrial organization of the banking system. Banking systems with well-diversified big banks are less prone to inefficient bank runs because diversification alleviates the information asymmetry. In addition, big banks can self-monitor through publicly observable branch closure. Systems of many small banks form incentive-compatible bank coalitions to emulate the big banks during times of crisis. Such coalitions improve efficiency by monitoring member banks and issuing money that is a kind of deposit insurance—a precursor of central banking.     

Anatomy of banking crises in developing and emerging market countries

This paper uses a Binary Classification Tree (BCT) model to analyze banking crises in 50 emerging market and developing countries during 1990-2005. The BCT model identifies three conditions (and the specific threshold of the key indictors) at which the vulnerability to banking crisis increases—(i) very high inflation, (ii) highly dollarized bank deposits combined with nominal depreciation or low bank liquidity, and (iii) low bank profitability—which highlight that foreign currency risk, poor financial soundness, and macroeconomic instability are important drivers of banking crises. The results also emphasize the importance of conditional thresholds in triggering crises, in that banking crises are underlined by a combination of vulnerabilities—or a sequence of (non-linear) conditions—rather than the deterioration of a unique factor.     

A reduced form model of default spreads with Markov-switching macroeconomic factors

We examine the ability of observed macroeconomic factors and the possibility of changes in regime to explain the proportion of yield spreads caused by the risk of default in the context of a reduced form model. For this purpose, we extend the Markov-switching risk-free term structure model of Bansal and Zhou (2002) to the corporate bond setting and develop recursive formulas for default probabilities, risk-free and risky zero-coupon bond yields as well as credit default swap premia. The model is calibrated with consumption, inflation, risk-free yields and default data for Aa, A and Baa bonds from the 1987 to 2008 period. We find that our macroeconomic factors are linked with two out of three sharp increases in the spreads during this sample period, indicating that the spread variations can be related to macroeconomic undiversifiable risk.