Income diversification and bank risk in Asia Pacific

This paper investigates the effect of income diversification on bank risk for a large sample of commercial banks in 14 Asia Pacific economies over the period 2011–2016. Using a dynamic panel data model with a system generalized methodof moments estimator, we find that banks with a higher level of income diversification are less risky in general. We further consider both developed and emerging economies according to the International Monetary Fund's classification of the level of economic development. Specifically, for emerging economies, the results indicate that banks with a higher level of income diversification face less risk. However, the diversification of commercial bank income has no significant impact on bank risk in developed Asia Pacific economies.     

Portfolio diversification and systemic risk in interbank networks

This paper contributes to a growing literature on the ambiguous effects of risk diversification. In our model, banks hold claims on each other’s liabilities that are marked-to-market on the individual financial leverage of the obligor. The probability of systemic default is determined using a passage-problem approach in a network context and banks are able to internalize the network externalities of contagion through their holdings. Banks do not internalize the social costs to the real economy of a systemic default of the banking system. We investigate the optimal diversification strategy of banks in the face of opposite and persistent economic trends that are ex-ante unknown to banks. We find that the optimal level of risk diversification may be interior or extremal depending on banks exposure the external assets and that a tension arises whereby individual incentives favor a banking system that is over-diversified with respect to the level of diversification that is desirable in the social optimum.     

Systemic financial risk indicators and securitised assets: an agent-based framework

The paper presents an agent-based model of a credit economy which includes a securitisation process and a bailout mechanism for bank bankruptcies. Within this framework, banks are able to sell mortgages to a financial vehicle corporation, which finances its activity by creating mortgage-backed securities and selling them to a mutual fund. In turn, the mutual fund collects liquidity by selling shares to households and remunerates them with a monthly interest. The impact of this mechanism is analysed by means of computational experiments for different levels of banks’ securitisation propensity. Furthermore, we study a set of systemic risk indicators which have the aim of assessing the imbalances in the financial system. Two of them are the mortgage-to-GDP ratio and the capital adequacy ratio, which are constructed to detect only the on-balance sheet changes in banks’ credit exposure. We consider two additional indicators, similar to the previous ones with the only difference that they are also able to account for the off-balance sheet items. Moreover, we adopt an indicator, the so-called “virtuous–unvirtuous cycle” indicator, which, besides off-balance assets, targets also the GDP. The results show that higher securitisation propensity weakens the financial stability of banks with relevant effects on different sectors of the economy. Most importantly, the analysis of systemic risk reveals the important issue of designing suitable systemic risk indicators for predicting incoming financial crises, finding that an essential feature of these indicators should be to integrate banks’ off-balance sheet assets.

     

The impact of bank competition and concentration on bank risk-taking behavior and stability: Evidence from GCC countries

This paper presents a comprehensive assessment of the impact of competition on bank fragility pre and post financial crisis period in the GCC banking market as measured by bank risk-taking behavior and bank stability during the period 1998–2016. Our results indicate that a higher level of bank competition and the greater degree of concentration adds to financial fragility. The findings further shows that during the 2008 crisis, lower bank competition maintain the stability of GCC banks. We also find that lower level of competition and lower concentration in the banking market increases the risk-taking behavior of the low capitalized, low liquid and small banks which add to fragility in the banking system. Our findings suggest that countries with greater capital stringency, greater supervisory power, greater market discipline, and private monitoring, with explicit deposit insurance schemes, higher shareholder protection, and higher legal efficiency decrease banks’ risk-taking and increase their stability. We also find that greater regulatory restrictions and higher creditor protection decrease banks’ stability and increase risk in concerned countries. We find support for both competition-fragility and competition-stability hypotheses in the GCC banking market. The results also confirm that the use of a single measure of competition is insufficient to assess the role of competition in banking stability.     

The double-edged sword effect of diversified operation on pre- and post-loan risk in the government-led Chinese commercial banks

Under the background of China’s deregulation of financial institutions since 2004, Chinese commercial banks have undergone remarkable change from traditional lending activities to universal fee-based activities. This paper explores the effect of diversified operation on bank credit activities. We find that diversification can reduce pre-loan risk but increase post-loan risk. Besides, enhanced disclosure requirement of other comprehensive income can mitigate pre- and post-loan risk under diversified operation. Additionally, in the state-owned commercial banks where government function is primary, diversification reduces both pre- and post-loan risk. This paper aims to reveal the double-edged sword effect of diversification in the Chinese commercial banks which are more government-led.     

Foreign banks and short-term macroeconomic fluctuations: Do financial development and regions matter?

In this paper, we investigate the association between bank integration, measured with the share of foreign banks in the banking industry, and macroeconomic volatility in emerging economies. We find a negative and significant relationship between bank integration and short-run fluctuations in output, consumption and investment, controlling for financial development, bank concentration and the real effective exchange rate. However, this relationship is found to be positive at high levels of financial development. We also explore the association at the regional level and show that the presence of foreign banks in Latin America is negatively and significantly correlated with macroeconomic volatility both in normal times and times of crisis. Despite widespread concerns in emerging Europe, which experienced greater financial vulnerability during the global financial crisis, we find no significant association between growth volatilities and bank integration.     

Networks and market-based measures of systemic risk: the European banking system in the aftermath of the financial crisis

This article investigates the behaviour of the European banking system during the financial crises that occurred in the last decades. Among the various approaches for measuring systemic risk, we consider network analysis, which describes the linkages among financial institutions and their whole structure. We construct a time-varying network of the European banking system. Banks are linked to form a global interconnected system and they mutually influence one another in terms of risk. We model their reciprocal influence via a weighted and directed network, in which weights are related to risk measures that are based on equity returns. Then, we apply two network indicators to investigate the prominence of a bank in spreading and receiving risk from the others. The results enable us to capture many features of the banking system while identifying the global systemically important banks. Moreover, the results of the analysis over time show how interconnections change over periods that are characterized by various economic scenarios.

     

Oil structural shocks,bank-level characteristics,and systemic risk: Evidence from dual banking systems

By performing a structural VAR analysis on oil price shocks, we provide an evidence on how the origins of oil price shocks impact the risk level of banks in oil-exporting countries and whether bank-level characteristics can influence the sensitivity of risk to oil shocks. When conducting panel regression analysis, we document the following findings. First, not all shocks have the same effect on bank risk. Due to oil supply shocks, the increase in oil price raises bank risk, whereas the similar increase in price due to economic expansion or oil-market specific demand reduces that risk. Second, the business model (whether the bank is Islamic or conventional), size, income diversification, profitability, and financial leverage influence the bank risk exposure to oil shocks differently. Third, the two major recent crises (global financial crises and COVID-19 pandemic) magnified bank risk exposure to oil supply shocks and speculative oil demand shocks. Overall, the structural oil shocks explain a large fraction of the variation in financial stability in GCC countries.     

Does financial regulation affect the profit efficiency and risk of banks? Evidence from China's commercial banks

The goal of financial regulation is to enable banks to improve liquidity and solvency. Stricter regulation may be good for bank stability, but not for bank efficiency. This research aims to examine whether banks have met the CBRC's standard of financial regulations and explores how the previously implemented financial regulations have affected bank efficiency and risk in the past. In addition, we also explored the trade-off relationship between efficiency and risk. Unlike other studies, this study used bank assets as a classification standard from the financial risk and differential regulatory perspective.The empirical results indicate that the CBRC regulates the provision coverage ratio and cost-to-income ratio, which seems relevant to large banks and the loan-to-deposit ratio, capital adequacy ratio, and leverage ratio, which seems relevant to small banks. The CBRC regulates the current ratio to reduce the risks of banks. Based on our empirical results, the current ratio did not affect the risks and led to different efficiency results between large and small banks. In an environment with asymmetric information, a bank decision-making is unobservable. The characteristics of financial regulation provide market clues if a bank is operating at the most efficiency and risk condition.     

Federal Home Loan Bank advances and bank risk

The Federal Home Loan Bank system (FHLB) has evolved into a major source of liquidity for the banking system with the demonstrated ability to borrow over a trillion dollars in world financial markets based on an implied U. S. Treasury guarantee. The FHLB loans the borrowed funds to commercial banks at reduced rates that are not adjusted for the risk of an individual bank. Moral hazard could cause member banks using FHLB loans to increase financial leverage and exposure to high risk assets. Conversely, the FHLB offers banks additional liquidity and specialized debt instruments that help them manage interest rate risk. We use dynamic panel generalized method of moments estimation to test the relation between FHLB advances and bank risk. We find that if banks have relatively normal default probabilities, advances are not associated with increased bank risk but, instead, advances are related to decreased interest rate risk. However, when bank default probabilities are high, our evidence suggests advances and higher bank risk are related.     

Instability spillovers in the banking sector: A spatial econometrics approach

In the study, we employ a dynamic spatial panel model to identify factors that are the sources of instability spillover in the banking sector. Using a sample of publicly listed banks, we document that the stability of a bank depends not only on its own characteristics and the macroeconomic conditions of its home country, but also on the stability of other banks in the same and other countries. We find weak evidence that the spillover effects are greater from domestic banks than from foreign ones. This study has significant implications for market regulators in terms of the role of country interdependence as a spillover mechanism during times of financial turbulence.     

Systemic risk governance in a dynamical model of a banking system with stochastic assets and liabilities

We consider the problem of governing systemic risk in an assets–liabilities dynamical model of a banking system. In the model considered, each bank is represented by its assets and liabilities. The net worth of a bank is the difference between its assets and liabilities and bank is solvent when its net worth is greater than or equal to zero; otherwise, the bank has failed. The banking system dynamics is defined by an initial value problem for a system of stochastic differential equations whose independent variable is time and whose dependent variables are the assets and liabilities of the banks. The banking system model presented generalizes those discussed in Fouque and Sun (in: Fouque, Langsam (eds) Handbook of systemic risk, Cambridge University Press, Cambridge, pp 444–452, 2013) and Fatone and Mariani (J Glob Optim 75(3):851–883, 2019) and describes a homogeneous population of banks. The main features of the model are a cooperation mechanism among banks and the possibility of the (direct) intervention of the monetary authority in the banking system dynamics. By “systemic risk” or “systemic event” in a bounded time interval, we mean that in that time interval at least a given fraction of banks have failed. The probability of systemic risk in a bounded time interval is evaluated via statistical simulation. Systemic risk governance aims to maintain the probability of systemic risk in a bounded time interval between two given thresholds. The monetary authority is responsible for systemic risk governance. The governance consists in the choice of assets and liabilities of a kind of “ideal bank” as functions of time and in the choice of the rules for the cooperation mechanism among banks. These rules are obtained by solving an optimal control problem for the pseudo mean field approximation of the banking system model. Governance induces banks in the system to behave like the “ideal bank”. Shocks acting on the banks’ assets or liabilities are simulated. Numerical examples of systemic risk governance in the presence and absence of shocks acting on the banking system are studied.

     

Financial Intermediaries,Credit Shocks and Business Cycles

We document the cyclical properties of aggregate balance sheet variables of the US commercial banks: (i) Bank credits and deposits are less volatile than output, while net worth and leverage ratio are several times more volatile, (ii) bank credits and net worth are procyclical, while deposits, leverage ratio and loan spread are countercyclical. We then present a real business cycle model with a financial sector to investigate how the dynamics of macroeconomic aggregates and balance sheet variables of the US banks are influenced by empirically disciplined shocks to bank net worth. Both calibrated and estimated versions of the model show that these financial shocks are important not only for explaining the dynamics of financial flows but also for the dynamics of macroeconomic variables. We find that the recent deterioration in aggregate net worth of the US banking sector contributed significantly to the 2007–09 recession.     

Financial fragility and distress propagation in a network of regions

We investigate how the financial fragility in the real economy is affected by the average level of interdependence among agents across different regions of the economy. To this end, we develop a parsimonious agent-based model of firms and banks organized in geographic regions. The model is built on the framework of an existing class of models for business fluctuations. The goal of our exercise is to clarify the effect on systemic failures of the interplay between network interconnectedness and financial acceleration. In particular, we investigate the probability of individual and systemic failures with varying levels of interconnectedness. We find that, in the absence of financial acceleration, connectivity makes the system more resilient. In contrast, in the presence of financial acceleration, the probability of both individual and systemic failures are minimized at intermediate level of diversification.     

Firm–bank credit network,business cycle and macroprudential policy

We present an agent-based model to study firm–bank credit market interactions in different phases of the business cycle. The business cycle is exogenously set, and it can give rise to various scenarios. Compared to other models in this literature strand, we improve the mechanism according to which the dividends are distributed, including the possibility of stock repurchase by firms. In addition, we locate firms and banks over a space and firms may ask credit to many banks, resulting in a complex spatial network. The model reproduces a long list of stylized facts and their dynamic evolution as described by the cross-correlations among model variables. The model allows us to test the effectiveness of rules designed by the current financial regulation, such as the Basel III countercyclical capital buffer. We find that the effectiveness of this rule changes in different business cycle environments and this should be considered by policy makers.

     

Factors influencing bank risk in Europe: Evidence from the financial crisis

We use a dynamic panel data model to analyze bank-specific and macroeconomic determinants of bank risk for a large sample of commercial banks operating in the euro area. The selected time span, from 2001 to 2012, considers the impact of the on-going financial and economic crisis on the Eurozone banking system. Our results indicate that capitalization, profitability, efficiency and liquidity are inversely and significantly related to bank risk. However, the recourse to wholesale funding by banks seems to increase their risk. We also find that less-concentrated markets, lower interest rates, higher inflation rates and a context of economic crisis (with a falling GDP) increase bank risk.     

Accounting enlightenment in the age of reason

We scrutinize the role financial reporting for fair values, asset securitizations, derivatives and loan loss provisioning played in the Financial Crisis. Because banks were at the center of the Financial Crisis, we focus our discussion and analysis on the effects of financial reporting by banks. We conclude fair value accounting played little or no role in the Financial Crisis. However, transparency of information associated with asset securitizations and derivatives likely was insufficient for investors to assess properly the values and riskiness of bank assets and liabilities. Although the FASB and IASB have taken laudable steps to improve disclosures relating to asset securitizations, in our view, the approach for accounting for securitizations in the IASB's Exposure Draft that would require banks to recognize whatever assets and liabilities they have after the securitization is executed better reflects the underlying economics of the securitization transaction. Regarding derivatives, we recommend disclosure of more disaggregated information, disclosure of the sensitivity of derivatives' fair values to changes in market risk variables, and implementing a risk-equivalence approach to enable investors to understand better the leverage inherent in derivatives. We also conclude that because the objectives of bank regulation and financial reporting differ, changes in financial reporting needed to improve transparency of information provided to the capital markets likely will not be identical to changes in bank regulations needed to strengthen the stability of the banking sector. We discuss how loan loss provisioning may have contributed to the Financial Crisis through its effects on procyclicality and on the effectiveness of market discipline. Accounting standard setters and bank regulators should find some common ground. However, it is the responsibility of bank regulators, not accounting standard setters, to ensure the stability of the financial system.     

Bank mergers and components of risk: An evaluation

The present study empirically examines the contribution of the acquired banks in only the nonconglomerate types of mergers (i.e., banks with banks), where the bulk of the payment is in the form of equity to the acquiring bank and finds overwhelmingly statistically significant evidence that nonconglomerate types of mergers definitely reduce the total as well as the unsystematic risk while having no statistically significant effect on systematic risk. Therefore, it seems that diversification may be a possible motive for bank mergers.     

Banks’ risk taking,financial innovation and macroeconomic risk

This paper shows how financial innovation in combination with the fall of macroeconomic risk can explain the strong growth of the primary and secondary credit markets in the U.S. economy. We document empirically the fall in macroeconomic risk, the expansion of the prime and secondary credit market and we provide evidence that changes in macroeconomic risk are closely related to the evolution of the prime market. In the theoretical part of the paper we study in a simple portfolio optimization framework the effect of financial innovation and macroeconomic risk on banks’ risk taking. The results of the model show that financial innovation increases bank appetite for risky investment both in the prime and secondary markets and that this effect is stronger in environments with low aggregate macroeconomic risk. In addition the banking system becomes less stable because of the portfolio risk of each individual bank increases.     

What drives the banks' diversification decision? A dynamic nonlinear panel data approach

This paper empirically determines the drivers of functional diversification decision for 365 banks set in selected Middle East and North Africa (MENA) countries over 1988–2015. For this purpose, we use a dynamic nonlinear panel data model. Our findings reveal that both market share and financial intermediation stratify the diversification decision for the whole MENA sample. Splitting the sample shows that the risk‐adjusted profitability and the loan loss provision ratio exert a major influence over the diversification indicator for Gulf Cooperation Council (GCC) banks, whereas the net interest margin ratio, the bank market share, and financial intermediation are the major drivers of the strategic decision for the remaining non‐GCC banks.