An analysis of bank risk and deposit rate ceilings: Evidence from the capital markets

The effect of deposit rate regulation on bank solvency is an important and unresolved issue that has received only limited attention. In this paper, capital market data is used to assess changes in both systematic and non-systematic risk of a portfolio of bank stocks at the time of deposit rate deregulation. The evidence indicates that neither measure of capital market risk is significantly affected, leading to the conclusion that bank solvency risk will not be increased by the deregulation of interest rates on deposits.     

互联网金融对中国商业银行系统性风险的影响——基于SVAR模型的实证研究

首先运用主成分分析法测算我国商业银行的系统性风险,接着运用突变分析和 SVAR 模型等计量方法实证互联网金融对我国商业银行系统性风险的影响。结果表明：互联网金融发展影响商业银行系统性风险的路径为：“互联网金融—商业银行的资产负债结构—商业银行的成本收入比—商业银行的系统性风险”,且它对银行系统性风险的影响存在“期限结构效应”,即互联网金融在短期内会增加我国银行系统性风险,但从中长期来看,对我国银行系统性风险的影响并不大,两者可作为互利共生的事物共同发展。互联网金融的存在对我国金融改革有很好的倒逼作用,能在一定程度上促进金融监管的创新。     

Manager wealth concentration,ownership structure,and risk in commercial banks

Of key importance in the governance structure of firms is the role of financial incentives for each major player. The main contribution of this article is an analysis of how an insider's concentration of wealth in his or her bank investment affects incentives to take risk. Major empirical findings are that, first, bank earnings variation falls when bank managers have more of their wealth concentrated in their banks; second, hired-manager banks become less risky when a person who has significant motivation to monitor bank management has his or her wealth highly concentrated in the bank; and third, stock ownership by hired managers can increase total risk of a bank. Further analysis suggests that community banks in our sample control earnings variation by manipulating idiosyncratic risk, credit risk, and leverage but not systematic risk or the loan-to-asset ratio.     

Do we need big banks? Evidence on performance,strategy and market discipline

For an international sample of banks, we construct measures of a bank’s absolute size and its systemic size defined as size relative to the national economy. We then examine how a bank’s risk and return on equity, its activity mix and funding strategy, and the extent to which it faces market discipline depend on both size measures. We show that bank returns increase with absolute size, yet decline with systemic size, while neither size measure is associated with bank risk as implicit in the Z-score. These results are consistent with the view that growing to a size that is systemic is not in the interest of bank shareholders. We also find that systemically large banks are subject to greater market discipline as evidenced by a higher sensitivity of their funding costs to risk proxies, consistent with the view that they can become too large to save. A bank’s interest costs, however, are estimated to decline with bank systemic size for all banks apart from those with very low capitalization levels. This suggests that market discipline, exercised through funding costs, does not prevent banks from attaining larger systemic size.     

Bank systemic risk and corporate investment: Evidence from the US

In this paper, we develop a simple two-period model in which a bank’s investment (e.g., loans) is influenced by short-term financing and a probability of a financial crisis. When banks ex ante expect to be bailed out during financial crises, they do not necessarily internalize the cost of financial crises and invest more. We argue that the level of systemic risk in the banking sector is largely driven by (1) the way in which banks finance their investment (e.g., loans) using more short-term debt and/or (2) the increase in asset commonality amongst banks. We use three measures that arguably capture two dimensions of “bank systemic risk”, namely, (1) bank funding maturity and (2) bank asset commonality, to empirically test whether bank systemic risk has a positive effect on corporate investment. We document that in a sample of publicly listed firms in the United States over the period 1991–2013, bank systemic risk is positively associated with the firm-level investment ratio after controlling for a large set of country- and firm-level variables. In addition, we show that a firm's leverage strengthens the positive effect of bank systemic risk on corporate investment, suggesting that more financially constrained firms experience a larger effect of bank systemic risk on corporate investment than less financially constrained firms.     

Deposit interest rate ceilings as credit supply shifters: Bank level evidence on the effects of Regulation Q

How did deposit interest rate ceilings, an important feature of the U.S. regulatory regime until the mid-1980s, affect individual banks’ lending and the transmission of monetary policy to credit? I estimate the effect of deposit rate ceilings inscribed in Regulation Q on commercial banks’ credit growth using a historical bank level data set starting in 1959. Banks’ credit growth contracted sharply when legally fixed deposit rate ceilings were binding. Interaction terms with monetary policy suggest that the policy impact on bank level credit growth was non-linear and significantly larger when rate ceilings were in place. Bank size and capitalization mitigate these effects. At the bank level, short-term interest rates exceeding the legally fixed deposit rate ceilings identify policy induced credit supply shifts that disappeared with deposit rate deregulation and thus weakened the bank lending channel substantially since the early 1980s.     

Asymmetric information and a theory of compensating balances

This paper derives an economic justification for the existence of compensating balance requirements using an equilibrium model of asymmetric information. Because bank profitability depends upon the probability distribution of a borrower's future cash requirements, and assuming this distribution is known by the borrower but not by the bank, compensating balance requirements can be used by the bank as a screen to distinguish among borrowers. Compensating balances are shown to exist without invoking assumptions of monopoly banks or non-maximizing behavior, and these balances need not be explained as a method of indirect payment for bank services.     

Exchange rates and ‘news’: Reply

In this reply I arge that the results of my 1982 article in this Journal are not affected, either at a theoretical or empirical level, by Longworth's (1984) comments. However, I also argue that Longworth's proposition of including variables pertaining to other countries in empirical market efficiency studies should be investigated further.     

The expansion of services in European banking: Implications for loan pricing and interest margins

Our study of 602 European banks over 1996–2002 investigates how the banks’ expansion into fee-based services has affected their interest margins and loan pricing. We find that higher income share from commissions and fees is associated with lower margins and loan spreads. The higher the commission and fee income share, moreover, the weaker the link between bank loan spreads and loan risk. The latter result is consistent with the conjecture that banks price (or misprice) loans to increase sales of other services. That loss leader (or cross selling) hypothesis has implications for bank regulation and competition with (non-bank) lenders.     

Joint Effects of Interest Rate Deregulation and Capital Requirements on Optimal Bank Portfolio Adjustments

The 1980 Depository Institution Deregulation and Monetary Control Act (DIDMCA) mandates that Regulation Q be phased out by 1986. With deregulation of interest rate ceilings, the cost of raising capital funds for commercial banks would become more volatile and more closely related with interest rates in the money and capital markets. Thus, value-maximizing bank managers would need to be concerned not only with the internal risk, but also with the external risk in bank portfolio management decisions. Based upon the cash flow version of the capital asset pricing model, this paper analyzes the joint impact of interest rate deregulation and capital requirements on the portfolio behavior of a banking firm.     

The effect of TARP on bank risk-taking

One of the largest responses of the US government to the recent financial crisis was the Troubled Asset Relief Program (TARP). TARP was originally intended to stabilize the financial sector through the increased capitalization of banks. However, recipients of TARP funds were then encouraged to make additional loans despite increased borrower risk. In this paper, we consider the effect of the TARP capital injections on bank risk-taking by analyzing the risk ratings of banks’ commercial loan originations during the crisis. The results indicate that, relative to non-TARP banks, the risk of loan originations increased at large TARP banks but decreased at small TARP banks. Loan levels also moved in different directions for large and small banks and, in supporting evidence, these effects are evaluated based on loan size and TARP repayment. For large banks, the increase in risk-taking without an increase in lending is suggestive of moral hazard due to government support. These results may also be due to the conflicting goals of the TARP program for bank recapitalization and bank lending.     

Can Banks in Emerging Economies Benefit from Revenue Diversification?

This paper investigates the effect of revenue diversification on bank performance and risk. Using a panel dataset of 226 listed banks across 11 emerging economies and a new methodological approach, System Generalized Method of Moments estimators (System GMM), the results in this paper provide empirical evidence of the impact of the observed shift towards non-interest income generating activities on insolvency risk and bank performance. The core finding is that diversification across and within both interest and non-interest income generating activities decrease insolvency risk and enhance profitability. The results also show that these benefits are largest for banks with moderate risk exposures. By extension, these results have significant strategic implications for bank managers, regulators and supervisors who share a common interest in boosting bank performance and stability.     

Executive stock options,differential risk-taking incentives,and firm value

The sensitivity of stock options' payoff to return volatility, or vega, provides risk-averse CEOs with an incentive to increase their firms' risk more by increasing systematic rather than idiosyncratic risk. This effect manifests because any increase in the firm's systematic risk can be hedged by a CEO who can trade the market portfolio. Consistent with this prediction, we find that vega gives CEOs incentives to increase their firms' total risk by increasing systematic risk but not idiosyncratic risk. Collectively, our results suggest that stock options might not always encourage managers to pursue projects that are primarily characterized by idiosyncratic risk when projects with systematic risk are available as an alternative.     

Bank runs and investment decisions revisited

We examine how the possibility of a bank run affects the investment decisions made by a competitive bank. Cooper and Ross [1998. Bank runs: liquidity costs and investment distortions. Journal of Monetary Economics 41, 27-38] have shown that when the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur; precautionary or “excess” liquidity will not be held. This result allows us to show that when the cost of liquidating investment early is high, an increase in the probability of a run will lead the bank to invest less. However, when liquidation costs are moderate, the level of investment is increasing in the probability of a run.     

Interest rates and bank risk-taking

A recent line of research views the low interest-rate environment of the early to mid 2000s as an element that triggered increased risk-taking appetite of banks in search for yield. This paper uses approximately 18000 annual observations on euro area banks over the period 2001-2008 and presents strong empirical evidence that low-interest rates indeed increase bank risk-taking substantially. This result is robust across a number of different specifications that account, inter alia, for the potential endogeneity of interest rates and/or the dynamics of bank risk. Notably, among the banks of the large euro area countries this effect is less pronounced for French institutions, which held on average a relatively low level of risk assets. Finally, the distributional effects of interest rates on bank risk-taking due to individual bank characteristics reveal that the impact of interest rates on risk assets is diminished for banks with higher equity capital and is amplified for banks with higher off-balance sheet items.     

Geopolitical,economic uncertainty and bank risk: Do CEO power and board strength matter?

This study examines whether economic and geopolitical uncertainties affect bank risk. Using a sample of 574 banks from 19 countries for 2009–2020, our findings show that increasing economic and geopolitical uncertainty significantly constrain the bank risk and worsens its stability. Furthermore, we explore whether CEO power and board strength have played a moderate role in mitigating the adverse impact of economic and geopolitical uncertainty on bank risk. The finding shows that CEOs' power and strong boards improve the bank's performance and minimize the adverse effects of economic and geopolitical uncertainty on bank risk. The results are robust to alternative bank risk, economic uncertainty, and geopolitical uncertainty measures and address endogeneity. Additional analyses on bank heterogeneity show that the bank stability of listed, domestic and private-owned banks is more immune to such uncertainty.     

Auditor choice and bank risk taking

We investigate the importance of auditor choice on bank risk-taking in a cross-country setting for 5498 banks from 116 emerging and developed countries. Using the Z-score as our main proxy for bank risk, we report evidence that hiring a Big Four auditing firm reduces bank-risk even after controlling for bank and country variables. The reported evidence is valid for banks outside the United States and is robust to concerns relating to endogeneity and alternative banking risk measures. The results are economically meaningful. All else constant, the Z-score of a bank audited by a Big Four firm is 10.4% higher than a similar bank with a non-BIG Four auditor. Moreover, consistent with the view that Big Four auditors serve a corporate governance mechanism in emerging markets, we find that Big Four auditors maintain the ability to curb bank risk in countries characterized by weak institutions. Finally, our results suggest that while audit quality is associated with bank safety, its impact is reduced in countries that require audit-oversight.     

Correspondent services and cost economies in commercial banking

Prior bank cost function studies have ignored the fact that some banks obtain a substantial amount of services from their correspondents. If these services are paid for with compensating deposit balances, their cost to the purchasing bank is not reflected in standard expense reports. This paper investigates whether explicit consideration of theese correspondent costs materially affects estimated bank returns to scale. The results indicate that the level of banksoperating costs is underreported by as much as 15%. While scale economy estimates for unit banks are not significantly affected by the addition of correspondent service costs, prior studies have overestimated branch bank scale economies by a small but statistically significant amount.     

Bank resilience to systemic shocks and the stability of banking systems: Small is beautiful

Utilising a novel empirical approach and an extensive sample of listed European banks, we identify which bank characteristics offer a shelter from systemic shocks and compare the relative effects of several hypothetical prudential rules on a bank’s risk exposure. While the results show that restrictions on a bank’s leverage ratio and the imposition of liquidity requirements, as in the Basel III Accord, may improve the resilience of a bank to systemic events, they also demonstrate that bank size, the share of non-interest income and asset growth (none of which are at the centre of the new regulatory landscape) are key determinants of a bank’s risk exposure. In particular, the introduction of a cap on bank absolute size appears the most effective tool, ceteris paribus, to reduce the default risk of a bank given systemic events. Furthermore, in spite of the integration process of the financial industry in Europe, the analysis presented here shows that such a cap should be country-specific with smaller economies requiring smaller banks. Finally, we show that the strengthening of individual bank stability obtained via size restrictions is accompanied by a reduction of the contribution to systemic risk for banks which are relatively large compared to the domestic economy.     

Subordinated Debt,Market Discipline,and Bank Risk

This paper demonstrates that subordinated debt (subdebt thereafter) regulation can be an effective mechanism for disciplining banks. By reducing the chance that managers of distressed banks can take value‐destroying actions to benefit themselves, subdebt regulation may encourage banks to lower asset risk. Moreover, subdebt regulation and bank capital requirements can be complements for alleviating the banks’ moral hazard problems. To make subdebt regulation effective, regulators may need impose ceilings on the interest rates of subdebt, prohibit collusion between banks and subdebt investors, and require subdebt to convert into the issuing bank's equity when the government provides assistance to the bank.