Using extreme value theory to estimate the likelihood of banking sector failure

Abstract

The growing interest in management of credit risk and estimation of default probabilities has given rise to a range of more or less elaborate credit risk models. While these models work well for non-financial firms they are usually not very successful in capturing the financial strength of banks. As an answer to this, Hall and Miles suggest a simple approach of estimating bank failure probabilities based solely on their stock prices. This paper suggests an extension to the Hall and Miles model using extreme value theory and applies the extended model to the Swedish banking sector around the banking crisis of the early 1990s. The extended model captures very well the increased likelihood of a systemic banking sector failure around the peak of the crisis and it produces default probabilities that are more stable, more realistic and more consistent with Moody’s and Fitch rating implied default rates than probabilities from the original Hall and Miles model.     

The identification of acquisition targets in the EU banking industry: An application of multicriteria approaches

In this paper we develop classification models for the identification of acquisition targets in the EU banking industry, incorporating financial variables that are mostly unique to the banking industry and originate from the CAMEL approach. A sample of 168 non-acquired banks matched with 168 acquired banks is used over the period 1998-2002, covering 15 EU countries. We compare and evaluate the relative efficiency of three multicriteria approaches, namely MHDIS, PAIRCLAS, and UTADIS, with all models developed and tested using a 10-fold cross validation approach. We find that the importance of the variables differs across the models. However, on the basis of univariate test and the results of the models we could state that in general after adjusting for the country where banks operate, acquired banks are less well capitalized and less cost and profit efficient. The results show that the developed models can achieve higher classification accuracies than a naïve model based on random assignments. Nevertheless, there is fair amount of misclassification that is hard to avoid given the nature of the problem, showing that as in previous studies for non-financial firms, the identification of acquisitions targets in banking is a difficult task.     

Measuring Integrated Market and Credit Risk in Bank Portfolios: An Application to a Set of Hypothetical Banks Operating in South Africa

The banking crises of the ‘90s emphasize the need to model the connections between financial environment volatility and the potential losses faced by financial institutions resulting from correlated market and credit risks. Due to the number of variables that must be modeled and the complexity of the relationships an analytical solution is not feasible. We present here a numerical solution based on a simulation model that explicitly links changes in the relevant variables that characterize the financial environment and the distribution of possible future bank capital ratios. This forward looking quantitative risk assessment methodology allows banks and regulators to identify potential risks before they materialize and make appropriate adjustments to bank portfolio credit qualities, sector and region concentrations, and capital ratios on a bank by bank basis. It also has the potential to be extended so as to assess the risks of correlated failures among a group of financial institutions (i.e., systemic risk analyses). This model was applied by the authors to the study of the risk profile of the largest South African Banks in the context of the Financial System Stability Assessment program undertaken by the IMF in 1999. In the current study, we apply the model to various hypothetical banks operating in the South African financial environment and assess the correlated market and credit risks associated with business lending, mortgage lending, asset and liability maturity matches, foreign lending and borrowing, and direct equity, real estate, and gold investments. It is shown to produce simulated financial environments (interest rates, exchange rates, equity indices, real estate price indices, commodity prices, and economic indicators) that match closely the assumed parameters, and generate reasonable credit transition probabilities and security prices. As expected, the credit quality and diversification characteristics of the loan portfolio, asset and liability maturity mismatches, and financial environment volatility, are shown to interact to determine bank risk levels. We find that the credit quality of a bank's loan portfolio is the most important risk factor. We also show the risk reduction benefits of diversifying the loan portfolio across various sectors and regions of the economy and the importance of accounting for volatility shocks that occur periodically in emerging economies. Banks with high credit risk and concentrated portfolios are shown to have a high risk of failure during periods of financial stress. Alternatively, banks with lower credit risk and broadly diversified loan portfolios across business and mortgage lending are unlikely to fail even during very volatile periods. Asset and liability maturity mismatches generally increase bank risk levels. However, because credit losses are positively correlated with interest rate increases, banks with high credit risk may reduce overall risk levels by holding liabilities with longer maturities than their assets. Risk assessment methodologies which measure market and credit risk separately do not capture these various interactions and thus misestimate overall risk levels.     

Market Implied Ratings and Financing Constraints: Evidence from US Firms

Financing constraints have been found to play an important role in several aspects of firm behavior, but no attention has been given to their effects on credit ratings. In this paper we analyze a unique and comprehensive data set for US firms rated by Fitch over the period 2001–07. We employ Fitch's market implied ratings derived from bond and equity prices. The analysis finds evidence that financial variables are more important in predicting credit ratings for firms likely to face financing constraints. We conclude that the financing constraint is an important dimension in the market implied ratings process. Our findings are of relevance to managers, investors and rating agencies seeking to understand the mechanism through which financing constraints affect credit ratings.     

The role of non-financial factors in internal credit ratings

Internal credit ratings are expected to gain in importance because of their potential use for determining regulatory capital adequacy and banks' increasing focus on the risk–return profile in commercial lending. Whereas the eligibility of financial factors as inputs for internal credit ratings is widely accepted, the role of non-financial factors remains ambiguous. Analyzing credit file data from four major German banks, we find evidence that the combined use of financial and non-financial factors leads to a more accurate prediction of future default events than the single use of each of these factors.     

Predicting banking distress in the EMEAP economies

This study develops a panel probit model to identify the leading indicators of banking distress and to estimate the banking distress probability for EMEAP economies. Macroeconomic fundamentals, currency crisis vulnerability, credit risks of banks and non-financial companies, asset price gaps, credit growth, and the occurrence of distress in other economies are found to be important leading indicators. The model is applied to stress test the Hong Kong banking sector. Simulation results suggest that compared with the period before the Asian financial crisis, the banking sector is currently more capable of withstanding shocks similar to those that occurred during the crisis.     

On the effects of banks�� equity ownership on credit markets

Recent deregulation of the banking sector in the US and in Europe allows commercial banks to hold equity in non-financial firms. We develop a model to investigate the effects of bank equity stakes in firms on credit market competition. The main result is that an equity stake confers a competitive advantage to the holding bank, which in equilibrium results in decreased competition in credit markets and higher interest rates being charged to firms. However, regulatory limits on the size of a bank’s stake may, under certain conditions, be counterproductive: they could actually strengthen the equity-owning bank’s competitive advantage. Our findings shed new light on the role of equity in lending relationships, and highlight that, in addition to the well-known prudential aspects, there is an antitrust dimension in the separation of banking and commerce.     

Ownership concentration and bank risk: international study on acquisitions

This paper explores the effects of different types of bank ownership concentration on changes in bank risk during acquisition years. Using multi-country data from 2000 to 2006, during which market failures caused by various crises and government interventions are less influential to acquisition decisions, we collect 505 banking acquisition deals from 23 countries to examine which type of ownership concentration (such as financial intermediary, capital investor, non-financial, and state ownership) brings larger changes to an acquirer’s risk from pre-acquisition year to post-acquisition year (including non-performing loans, capital adequacy ratio, loan loss reserve, and credit rating). The empirical analyses show that acquirer banks with a concentration of shares owned by financial intermediaries and non-financial firms experience larger risk changes during acquisition years. In contrast, the risk changes of acquirer banks with a concentration of capital investors and state ownership are lower. Robustness checks from the random effect estimation, instrumental variables model, reverse causality, and different subsamples of (non-)U.S. or different levels of regulation enforcement confirm these results.     

Japan’s banking crisis: An event-study perspective

We calculate abnormal stock returns for Japanese non-financial companies around major events associated with the banking crisis (1995–2000), and find that not all companies were equally sensitive to the malaise of the banking sector: the most affected were small, leveraged, low-tech companies with low credit ratings and low market to book ratios. This is consistent with “credit crunch” theories (companies with limited access to financial markets are sensitive to changes in bank lending) and with claims that innovation is rarely financed by bank debt. We do not find much evidence on the alleged misallocation of loans to support ailing bank clients.     

Institutions,moral hazard and expected government support of banks

We model the expected support of banks with credit ratings from Moody's and Fitch, taking explicitly into account the capacity and willingness of governments to provide support in case of need, as well as their concerns about moral hazard (i.e., that the expected support may induce banks to assume bigger risks). Our results suggest that moral hazard concerns are relatively weak. In addition, a substantial part of the expected support can be attributed to the quality of a country's institutions. These findings have important implications for the dynamics of banking crises, the value of the ‘fair’ insurance premium banks might be called upon to pay for the expected support, as well as for ways to reduce the resulting negative externalities.     

我国商业银行中小企业信贷风险评估体系的构建

开展中小企业贷款业务是商业银行优化信贷资产结构的重要措施,快速、准确评估其信贷风险是商业银行亟须解决的技术问题.经过长期实地调研,本文建立了适用于我国的中小企业信贷风险评估体系,其中,所建非财务指标体系,从行业环境、企业经营管理水平、经营者经验与素质、信用品质四方面进行评估;财务指标体系包括现金流流动负债比、净资产总资产比、息税前利润流动负债比、总资产周转速度、流动比率、现金流贷款比六个指标.以Logit统计回归模型为基础建立的评估模型,在分别评估非财务指标信息和财务指标信息后,加权相加两方面结果得到综合评估结果.实证检验证明,该评估体系的评估正确率达到95%以上.     

非金融企业杠杆率与银行信用风险关系研究

本文立足于重庆市非金融企业杠杆率的测算,采用描述性统计分析、变异系数法、向量自回归模型分析等分析方法,重点分析了重庆市非金融企业杠杆率的发展情况及非金融企业杠杆率与商业银行信用风险之间的关系。研究结果表明：重庆市非金融企业杠杆率总体稳定可控,但部分行业风险不容忽视;去杠杆短期内会增加商业银行信用风险,长期有助于化解金融风险;去杠杆对商业银行不良率攀升的影响较为显著。据此,根据研究结论提出了相应的对策建议。     

Ownership structure and risk in publicly held and privately owned banks

Using detailed ownership data for a sample of European commercial banks, we analyze the link between ownership structure and risk in both privately owned and publicly held banks. We consider five categories of shareholders that are specific to our dataset. We find that ownership structure is significant in explaining risk differences but mainly for privately owned banks. A higher equity stake of either individuals/families or banking institutions is associated with a decrease in asset risk and default risk. In addition, institutional investors and non-financial companies impose the riskiest strategies when they hold higher stakes. For publicly held banks, changes in ownership structure do not affect risk taking. Market forces seem to align the risk-taking behavior of publicly held banks, such that ownership structure is no longer a determinant in explaining risk differences. However, higher stakes of banking institutions in publicly held banks are associated with lower credit and default risk.     

德国利率市场化改革的特点与其金融业发展

利率市场化是指金融机构在货币市场经营融资的利率由市场供求来决定,它包括利率决定、利率传导、利率结构和利率管理的市场化。文章考察了德国利率市场化改革的特点及其对金融业发展的积极影响。德国利率市场化改革分步骤平稳推进。改革后,在全能银行模式下德国金融业没有出现象美、英那样的银行集中倒闭危机;银行贷款在非金融部门融资中仍居于主导地位,而住户部门的金融资产结构发生显著变化;德国的货币政策主要是通过改变银行的流动性来影响金融市场利率,进而间接影响银行信贷政策以及实体经济。     

The complementary relationship between financial and non-financial information in the biotechnology industry and the degree of investor sophistication

We examine whether financial and non-financial variables, separately and in tandem, are value relevant in explaining market returns, equity values and the degree of investment by sophisticated investors for a sample of drug development companies. Patent counts, number of collaborations and probability-adjusted portfolios of drugs under development are the non-financial information metrics used in this study. Earnings are the main financial information variable. We show that news about these non-financial measures is significantly associated with abnormal returns. We also find that earnings are value relevant in explaining cumulative abnormal returns and equity prices around earnings announcement dates despite the fact that R&D expenditures are large and usually expensed as incurred. We further show that non-financial information is value relevant in explaining annual returns, equity prices and degree of investment by (long-horizon) sophisticated investors. Moreover, non-financial variables are value relevant after controlling for financial variables suggesting that the two types of variables are complements.     

金融错配、非金融企业影子银行化与经济“脱实向虚”

当前,我国一些非金融企业通过直接或间接的方式从事影子银行业务。本文利用2004-2015年上市公司数据研究发现,金融错配程度的提高整体上会提高企业影子银行化规模,并且这种效应仅在金融深化程度较高、经济资源市场化配置程度偏低的地区显著;僵尸企业和盈利性较差的企业,分别受到“利润追逐”和“投资替代”机制的影响,金融错配对其影子银行化趋势的正向作用更为明显。机制检验发现,金融错配水平的上升通过提高融资约束程度从而降低企业实体投资水平,这种效应在资产专用性较强的企业中更为明显;金融错配主要通过融资约束程度和实体投资规模,而非资本回报率渠道作用于企业影子银行化行为。本文研究对于提高信贷资源配置效率,防范经济“脱实向虚”具有较强的政策意义。     

The patterns of cross-border bank mergers and shareholdings in OECD countries

In recent years there has been a surge in mergers and acquisitions (M&As) in all sectors of economic activity. Cross-border operations have followed this trend, creating global companies operating in all major world markets. In this paper we study the pattern of cross-border M&As in the banking industry relative to the non-financial sector of the economy and investigate which factors make it more likely that a bank will expand its activities abroad. We find that cross-border M&As are rarer in banking than in other sectors, possibly owing to the importance of information asymmetries in banking relationships and to regulatory restrictions. Using data on almost 2500 banks from 29 OECD countries, we also show that the most significant features of banks with foreign equity interests relate to efficiency: banks with cross-border shareholdings are on average larger, more profitable, and based in countries with a more highly developed banking market.     

Is There a Difference Between Solicited and Unsolicited Bank Ratings and, If So, Why?

This paper analyses the effect of soliciting a rating on the actual outcome of bank ratings. Using two sample banks (one rated by Fitch and one rated by S&P), I find evidence that unsolicited ratings tend to be lower than solicited ones, after accounting for differences in observable bank characteristics. This downward bias does not seem to be explained by the fact that better-quality banks self-select into the solicited group. Rather, unsolicited ratings appear to be lower because they are based on public information and are therefore dependent on the quantity of public information disclosed by the banks. As a result, unsolicited ratings tend to be more conservative than solicited ratings, which incorporate both public and non-public information. While the latter result is also consistent with the fact that credit rating agencies may blackmail low-disclosure firms, the findings suggest that blackmailing—if it is actually used—is ineffective in making these firms start to pay for a rating.     

A multivariate analysis of the determinants of Moody’s bank financial strength ratings

In 1995 Moody’s Investors Services inaugurated a new rating service, bank financial strength ratings (BFSRs), that assesses the safety and soundness of banks in over 50 countries. Our study sets out to do some preliminary investigations of this new type of credit rating. We develop logistic regression models to help explain or predict BFSRs. Using bank-specific accounting and financial data we are able to correctly classify or predict BFSRs. These fundamental variables cover the dimensions of risk, loan provision ratios, and profitability. Of the three, loan provisions is the most important factor, followed by risk, and then profitability. Country risk ratings do not appear to be significant explanators of BFSRs. We also find that traditional debt ratings accurately classify BFSRs and this raises the question of whether BFSRs add incremental information. The paper also highlights future directions for our research. One such area is to examine how well BFSRs predict banking crises such as the credit problems currently affecting Asia and Latin America.     

Do Solicitations Matter in Bank Credit Ratings? Results from a Study of 72 Countries

Would the credit ratings of unsolicited banks be higher if they were solicited? Alternatively, would the credit ratings of solicited banks would be lower if they were unsolicited? To answer these questions, we use an endogenous regime-switching model and data from 460 commercial banks in 72 countries, excluding the United States, for the period 1998–2003. The answer to both questions is yes. Our results show that the observed differences between solicited and unsolicited ratings can be explained by both the solicitation status and financial profile of the banks. This finding is a new contribution to the literature.