The international transmission of bank capital requirements: Evidence from the UK

We use data on UK banks? minimum capital requirements to study the impact of changes to bank-specific capital requirements on cross-border bank loan supply from 1999Q1 to 2006Q4. By examining a sample in which each recipient country has multiple relationships with UK-resident banks, we are able to control for demand effects. We find a negative and statistically significant effect of changes to banks? capital requirements on cross-border lending: a 100 basis point increase in the requirement is associated with a reduction in the growth rate of cross-border credit of 5.5 percentage points. We also find that banks tend to favor their most important country relationships, so that the negative cross-border credit supply response in “core” countries is significantly less than in others. Banks tend to cut back cross-border credit to other banks (including foreign affiliates) more than to firms and households, consistent with shorter maturity, wholesale lending which is easier to roll off and may be associated with weaker borrowing relationships.     

Characteristics determining the efficiency of foreign banks in Australia

The factors determining foreign bank efficiency are investigated using a three stage research method. It is found that host market incumbency reduces efficiency of foreign banks in Australia, resulting in over use of inputs. Factors underlying the limited global advantage hypothesis of Berger et al. [Berger, Allen N., DeYoung, Robert, Genay, Hesna, Udell, Gregory F., 2000. Globalisation of financial institutions: Evidence from cross-border banking performance. Brookings-Wharton Papers on Financial Service 3, 23–120] are identified, in that nationality specific factors represented by dummy variables are not significant once other relevant effects are controlled for. Parent profitability is not found to result in increased host nation efficiency, while parent credit rating effects are mixed. Some evidence is presented that banks from more financially sophisticated nations are more efficient. The implications of these results are explored from the perspectives of bank management and bank regulators.     

Competitive conditions among the major British banks

This paper reports an empirical assessment of competitive conditions among the major British banks, during a period of major structural change. Specifically, estimates of the Rosse–Panzar H-statistic are reported for a panel of 12 banks for the period 1980–2004. The sample banks correspond closely to the major British banking groups specified by the British Banking Association. The robustness of the results of the Rosse–Panzar methodology is tested by estimating the ratio of Lerner indices obtained from interest rate setting equations. The results confirm the consensus finding that competition in British banking is most accurately characterised by the theoretical model of monopolistic competition. There is evidence that the intensity of competition in the core market for bank lending remained approximately unchanged throughout the 1980s and 1990s. However, competition appears to have become less intense in the non-core (off-balance sheet) business of British banks.     

Using accounting ratios to distinguish between Islamic and conventional banks in the GCC region

This study determines whether it is possible to distinguish between conventional and Islamic banks in the Gulf Cooperation Council (GCC) region on the basis of financial characteristics alone. Islamic banks operate under different principles, such as risk sharing and the prohibition of interest, yet both types of banks face similar competitive conditions. The combination of effects makes it unclear whether financial ratios will differ significantly between the two categories of banks. We input 26 financial ratios into logit, neural network, and k-means nearest neighbor classification models to determine whether researchers or regulators could use these ratios to distinguish between the two types of banks. Although the means of several ratios are similar between the two categories of banks, non-linear classification techniques (k-means nearest neighbors and neural networks) are able to correctly distinguish Islamic from conventional banks in out-of-sample tests at about a 92% success rate.     

Ratings based capital adequacy for securitizations

This paper develops a framework to measure the exposure to systematic risk for pools of asset securitizations and measures empirically whether current ratings-based rules for regulatory capital of securitizations under Basel II and Basel III reflect this exposure. The analysis is based on a comprehensive US dataset on asset securitizations for the time period between 2000 and 2008. We find that the shortfall of regulatory capital during the Global Financial Crisis is strongly related to ratings. In particular, we empirically show that insufficient capital is allocated to tranches with the highest rating. These tranches account for the greatest part of the total issuance volumes. Furthermore, this paper is the first to calibrate risk weights which account for systematic risk and provide sufficient capital buffers to cover the exposure during similar economic downturns. These policy-relevant findings suggest a re-calibration of RBA risk weights and may contribute to the current efforts by the Basel Committee on Banking Supervision and others to re-establish sustainable securitization markets and to improve the stability of the financial system.     

Analysing the determinants of performance of best and worst European banks: A mixed logit approach

Using a dataset of 7635 observations on 1384 commercial banks operating in the EU between 1993 and 2001, we utilise a mixed logit model to identify factors that explain the probability of a bank being a best [worst] performer. The empirical evidence confirms the importance of country-level characteristics (location and legal tradition), and firm-level features (bank ownership, balance sheet structure and size). Specifically, smaller sized banks with higher loan-intensity, and foreign banks from countries upholding common law traditions have a higher probability of best performance.     

Productivity and efficiency analysis of Shinkin banks: Evidence from bootstrap and Bayesian approaches

This paper analyzes the productivity and efficiency of Shinkin banks and the various prefectures in Japan, over the period from 2000 to 2006. We obtain estimates of efficiency growth and productivity growth, using the bootstrapped Malmquist index, and estimates of efficiency using the Bayesian distance frontier approach. We confirm that the efficiency growth and productivity growth of Shinkin banks did not improve significantly over the period of this study. In addition, we show that the efficiency of Shinkin banks is homogenous, with little variation across the banks analyzed. Methodologically, we also prove that a failure to impose theoretical regularity on the distance function could lead to false conclusions about the average efficiency or efficiency ranking of Shinkin banks. The study also includes an analysis of the correlates of productivity and efficiency growth, and provides efficiency and productivity estimates of the prefectures in which the banks are located.     

Small European banks: Benefits from diversification?

Motivated by the liberalisation and harmonisation of financial systems in Europe, we investigate whether the observed shift into non-interest income activities improves performance of small European credit institutions. Using a sample of 755 small banks for the period 1997–2003, we find no direct diversification benefits within and across business lines and an inverse association between non-interest income and bank performance. Our findings are robust to a set of sensitivity analyses using alternative samples and controlling for the regulatory environment. Furthermore, the results provide circumstantial evidence for the presence of economies of scale. The absence of benefits of diversification confirms findings for other banking markets and suggests small European banks enter lines of business where they currently lack expertise and experience. These results have implications for bank supervisors, regulators and bank managers.     

Potential cost synergies from banks acquiring real estate brokerage services

National banks and Financial Holding Companies (FHC) solicited permission from the Federal Reserve Board and the Treasury Department to add real estate brokerage and management services to list of permissible business activities under the 1999 Gramm–Leach–Bliley Act (GLB). To date, permission has been denied due to the Community Choice in Real Estate Act, HR 111 and S 98.     

First Financial Restructuring and operating efficiency: Evidence from Taiwanese commercial banks

This paper investigates the effect of the “First Financial Restructuring” (FFR) on the operating efficiency of commercial banks in Taiwan. Applying data envelopment analysis (DEA) to operations data for 40 commercial banks over the 6-year period 2000–2005, we find that while the banks have lower operating efficiency on average during the reform period (2002–2003) compared to the pre-reform period (2000–2001), improved operating efficiency is reflected in the post-reform period (2004–2005). Our results remain unchanged even after controlling for the non-performing loan ratio, capital adequacy ratio, bank ownership, size, and GDP growth rate. These results suggest that the improved efficiency in the post-reform period is possibly due to enhanced banking and risk management practices and benefits obtained from compliance with the FFR.     

Return sign forecasts based on conditional risk: Evidence from the UK stock market index

Recent theoretical works have found a link between return sign forecastability and conditional volatility. This paper compares the predictive performance of the conditional country risk and the conditional residual risk in forecasting the direction of change in the return on the UK stock market index. The conditional country risk and the conditional residual risk are estimated using the bivariate BEKK-GARCH technique and the direction of change in the UK stock market index is modelled using the binary logit approach. Both the in-sample and the out-of-sample predictions suggest that, as a predictor, the conditional residual risk is superior to the conditional country risk. Our findings support the residual risk model while contradicting the traditional capital asset pricing model (CAPM). Moreover, our tactical asset allocation simulations show that when the conditional residual risk is used in conjunction with multiple-threshold trading strategies to guide the investment decisions, the actively managed portfolio achieves greater returns than the return on a buy and hold portfolio.     

Why Commercial Banks Held Excess Reserves: The Japanese Experience of the Late 1990s

We investigated, empirically, why Japanese banks held excess reserves in the late 1990s. Specifically, we pin down two factors explaining the demand for excess reserves: a low short-term interest rate, or call rate, and the fragile financial health of banks. The virtually zero call rate increased the demand for excess reserves substantially, and a high bad loans ratio largely contributed to the increase in excess reserve holdings. We found that the holdings of excess reserves would fall by two-thirds if the call rate were to be raised to its level prior to the adoption of the zero-interest-rate policy, and the bad loans ratio were to fall by 50%.     

Identifying the balance sheet and the lending channels of monetary transmission: A loan-level analysis

We make a novel attempt at comparing the strength of the lending and balance sheet channels of monetary transmission. To make this comparison, we use loan-level data to determine how borrower balance sheets and bank liquidity are related to bank lending decisions and how monetary policy can affect these relationships. The key innovation in this paper is the use of loan-level data. This enables us to measure the independent effects of the two channels and directly account for borrower balance sheets and lender liquidity instead of using proxies. Our results show that the balance sheet channel is the main mechanism through which monetary policy shocks are transmitted to the economy and that the lending channel does not play a significant role.     

Bank regulatory capital and liquidity: Evidence from US and European publicly traded banks

The theory of financial intermediation highlights various channels through which capital and liquidity are interrelated. Using a simultaneous equations framework, we investigate the relationship between bank regulatory capital and bank liquidity measured from on-balance sheet positions for European and US publicly traded commercial banks. Previous research studying the determinants of bank capital buffer has neglected the role of liquidity. On the whole, we find that banks decrease their regulatory capital ratios when they face higher illiquidity as defined in the Basel III accords or when they create more liquidity as measured by Berger and Bouwman (2009). However, considering other measures of illiquidity that focus more closely on core deposits in the United States, our results show that small banks strengthen their solvency standards when they are exposed to higher illiquidity. Our empirical investigation supports the need to implement minimum liquidity ratios concomitant to capital ratios, as stressed by the Basel Committee; however, our findings also shed light on the need to further clarify how to define and measure illiquidity and also on how to regulate large banking institutions, which behave differently than smaller ones.     

Stock market bubbles, inflation and investment risk

This paper proposes an autoregressive regime-switching model of stock price dynamics in which the process creates pricing bubbles in one regime while error-correction prevails in the other. In the bubble regime the stock price depends negatively on inflation. In the error-correction regime it depends on the price-dividend ratio. We find that the probability of regime-switch depends on exogenous inflation and lagged price. The model is consistent with Shleifer and Vishny's theoretical noise trader and arbitrageur model and Modigliani's inflation illusion phenomenon. The results emphasize the importance of inflation and the price-dividend ratio when assessing investment risk.     

Systemic risk and diversification across European banks and insurers

The mutual and cross company exposures to fat-tail distributed risks determine the potential impact of a financial crisis on banks and insurers. We examine the systemic interdependencies within and across the European banking and insurance sectors during times of stress by means of extreme value analysis. While insurers exhibit a slightly higher interdependency in comparison with banks, the interdependency across the two sectors turns out to be considerably lower. This suggests that downside risk can be lowered through financial conglomeration.     

Bank loan recovery rates: Measuring and nonparametric density estimation

In this paper we analyse a comprehensive database of 149,378 recovery rates on Italian bank loans. We investigate a new methodology to compute the recovery percentage that we suggest to consider as a mixed random variable. To estimate the probability density function of such a mixture, we propose the mixture of beta kernels estimator and we analyse its performance by Monte Carlo simulations. The application of these proposals to the Bank of Italy’s data shows that, even if we remove the endpoints from the support of the recovery rate, the density function estimate is far from being a beta function.     

Market discipline, financial crisis and regulatory changes: Evidence from Indonesian banks

Following the 1997/1998 financial crisis, Indonesian banks experienced major regulatory changes, including the adoption of the blanket guarantee scheme (BGS) in 1998, a limited guarantee (LG) in 2005, and changes in capital regulation in 1998 and 2001. We examine the impact of these regulatory changes on market discipline during the period 1995-2009. The price of deposits is used to measure market discipline in a dynamic panel data methodology on a sample of 104 commercial banks. We find a weakening of market discipline following the introduction of the BGS. The result is consistent with the deposit insurance scheme being credible in the lower capital requirement environment. The adoption of LG in a recovering economy also mitigates the role of market discipline. However, market discipline is more pronounced in listed banks than unlisted banks and in foreign banks than domestic banks. These results have important implications for banking regulation and supervision, particularly during a crisis period.     

The effects of focus versus diversification on bank performance: Evidence from Chinese banks

This paper investigates the effects of focus versus diversification on bank performance using data on Chinese banks during the 1996–2006 period. We construct a new measure, economies of diversification, and compare the results to those of the more conventional focus indices, which are based on the sum of squares of shares in different products or regions. Diversification is captured in four dimensions: loans, deposits, assets, and geography. We find that all four dimensions of diversification are associated with reduced profits and higher costs. These results are robust regardless of alternative measures of diversification and performance. Furthermore, we observe that banks with foreign ownership (both majority and minority ownership) and banks with conglomerate affiliation are associated with fewer diseconomies of diversification, suggesting that foreign ownership and conglomerate affiliation may play important mitigating roles. This analysis may provide important implications for bank managers and regulators in China as well as in other emerging economies.