Sub-debt Yield Spreads as Bank Risk Measures

Several recent studies have recommended greater reliance on subordinated debt as a tool to discipline bank risk taking. Some of these proposals recommend using sub-debt yield spreads as triggers for supervisory discipline under prompt corrective action (PCA). Currently such action is prompted by capital adequacy measures. This paper provides the first empirical analysis of the relative accuracy of various capital ratios and sub-debt spreads in predicting bank condition: measured as subsequent CAMEL or BOPEC ratings. The results suggest that some of the capital ratios, including the summary measure used to trigger PCA, have almost no predictive power. Sub-debt yield spreads performed slightly better than the best capital measure, the Tier-1 leverage ratio, albeit the difference is not significant. The performance of sub-debt yields satisfies an important pre-requisite for using sub-debt as a PCA trigger. However, the prediction errors are relatively high and further work to refine the measures would be desirable.     

金融危机后对美国即时矫正措施的反思

即时矫正措施制度源自美国,并逐渐成为世界各国预防银行破产制度效仿的蓝本.然而2007年以来次贷危机的爆发和蔓延,暴露了该制度的缺欠.金融危机中即时矫正措施未能达到有效预防银行破产的效果.其主要原因是监管参数的设置存在重大缺陷.由于资本充足率的计算并未涵盖银行经营的伞部风险,因此仪以资本充足状况作为唯一指标来判断银行的经营状况并进而采取矫正措施存在片面性.中国的即时矫正措施的监管参数设置同样存在不合理性,需要汲取美国的经验教训予以重构.     

Dynamic Prudential Regulation: Is Prompt Corrective Action Optimal?

The current U.S. bank capital regulation features prompt corrective action, which mandates regulators to intervene in and liquidate banks based on their book‐value capital ratios. To see if prompt corrective action is optimal, I build a dynamic model of repeated interactions between a banker and a regulator. Under hidden choice of risk, private information on returns and limited commitment by the banker, and costly liquidation, I first characterize the optimal incentive‐feasible allocation. I then demonstrate that the optimal allocation is implementable through the combination of a risk‐based deposit insurance premium and a book‐value capital regulation with stochastic liquidation.     

The impact of FDICIA and prompt corrective action on bank capital and risk: Estimates using a simultaneous equations model

One of the requirements of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) was that bank regulators establish capital ratio zones that mandate prompt corrective action (PCA) and early intervention in troubled banks. However, prior research suggests that increases in regulatory capital standards can lead to offsetting increases in risk. This paper develops and estimates a 3SLS model to examine the simultaneous impact of PCA on both bank capital and credit risk. The results document that the FDICIA was effective in that, subsequent to its passage, US banks increased their capital ratios without offsetting increases in credit risk.     

Bank Capital Ratios Across Countries: Why Do They Vary?

This paper extends the literature on bank capital structure by modeling capital structure as a function of important public policy and bank regulatory characteristics of the home country, as well as of bank specific variables, country macro-economic conditions and country level financial characteristics. The model is estimated with annual data for an unbalanced panel of the 78 largest private banks in the world headquartered in 12 industrial countries over the period between 1992 and 2005. The results indicate that bank capital ratios are significantly affected in the hypothesized directions by most of the bank-specific variables. Several of the country characteristic and policy variables are also significant with the predicted sign: banks maintain higher capital ratios in home countries in which the bank sector is relatively smaller and in countries that practice prompt corrective actions more actively, have more stringent capital requirements, and have more effective corporate governance structures.     

When time is not on our side: The costs of regulatory forbearance in the closure of insolvent banks

In this paper, we empirically estimate the costs of delay in the FDIC's closures of 433 commercial banks between 2007 and 2014 based upon a counterfactual closure regime. We find that the costs of delay could have been as high as $18.5 billion, or 37% of the FDIC's estimated costs of closure of $49.8 billion. We think that these findings call for a more aggressive stance by bank regulators with respect to the provisions for loan losses and write-downs of banks’ non-performing assets. More aggressive (and earlier) provisions and write-downs, or adoption of a capital ratio that penalizes nonperforming loans, would allow the concept of “prompt corrective action” (PCA) to play the role that it was meant to play in reducing FDIC losses from insolvent banks.     

Cross-border banking and financial stability in the EU

This paper examines the implications that alternative regulatory structures may have for resolving failed banking institutions. Emphasis on the European Union (EU), which is both economically and financially large and has several features relating to cross-border banking in the form of direct investment that may heighten the problems we consider. To ensure the efficient resolution of bank failures with minimum, if any, credit and liquidity losses a four step program should be followed. This includes prompt legal closure of institutions before they become economically insolvent, prompt identification of claims and assignment of losses, prompt reopening of failed institutions, and prompt re-capitalizing and re-privatization of failed institutions. These policies together with a prompt corrective action system could be voluntarily adopted through the use of deposit insurance premium discounts as an incentive.     

Financial regulation in Japan: a sixth year review of the Financial Services Agency

The paper provides a critical review of the Financial Services Agency (FSA) of Japan since its establishment in June 1998 (as the Financial Supervisory Agency) to June 2004. During the six year period, the FSA faced the challenge of addressing severe insolvency problems in banking as well as life insurance industries. The paper argues that the initial separation of the supervisory role (in the Financial Supervisory Agency and the Financial Reconstruction Commission) and the policy planning role (in the Ministry of Finance) was useful in the sense it allowed the FSA to have a firm stance on the insolvency problem that was partially created by the failure of the past financial regulatory policy. Even after the creation of the FSA, the Bank of Japan remained as another bank supervisor. This seems have made the central bank reluctant in relaxing monetary policy out of the fear that such loose monetary policy would actually discourage re-organization of banking industry. This suggests a problem of having the central bank as a bank supervisor. For the life insurance companies, the FSA (both old and new) has not been successful in intervening (using prompt corrective action) before the failures. Finally, the paper also points out the important role of the leadership at the FSA that shapes the financial regulation, and suggests a problem of appointing a politician to this role.     

BANK REGULATIONS,CAPITAL STRUCTURE,AND RISK

The joint influence of the Federal Reserve's (Fed) discount window credit and reserve requirements and FDIC's deposit insurance on a bank's optimal capital structure and asset risk choices is analyzed. The specific seniority of such regulatory claims, and potentially strong negative correlation between bank asset classes, significantly alters our traditional view of such regulatory influences on bank behavior. I find that the discount window's presence does not always prompt bank risk taking and leverage, but it does partially offset such incentives under certain conditions. In addition to its cost, a reserve requirement provides the bank with an indirect subsidy that may encourage deposit funding. Thus, regulatory reforms, such as the FDIC Improvement Act of 1991, which curtail banks' access to the discount window, may not always be appropriate to resolve a bank's incentive for moral hazard behavior. The Fed's presence needs to be more comprehensively examined to design effective regulatory policy.     

Basel II vs. Prompt Corrective Action: Which Is Best for Public Policy?

This paper evaluates Basel II as a tool for achieving public policy objectives relative to structured early intervention and resolution (SEIR) and prompt corrective action (PCA) in the U.S. It concludes that Basel II compares poorly in terms of maintaining a safe and sound banking system. Rather, Basel II resembles a "best practices" guide for banks in managing their credit risk. However, it may do damage through encouraging some large banks in the U.S. to successfully pressure their regulators to lower the capital trigger ratio for "adequately‐capitalized" status in order to benefit from any lower regulatory capital requirement that Basel II may give them.     

Optimal Forbearance of Bank Resolution

This paper analyzes a regulator's optimal strategic delay of resolving banks when the regulator's announcement of the intervention delay endogenously affects the depositors' run propensity. Given intervention, the regulator either liquidates the remaining illiquid assets (“prompt corrective action”) or continues managing the assets at a reduced skill level (“resolution under receivership”). In either case, I show that if the regulator tolerates fewer withdrawals until intervention, the depositors may react by preempting the regulator: they run on the bank more often ex ante. A policy of never intervening can leave the bank more stable than a conservative intervention policy.     

Who pays for bank insolvency in transition and emerging economies?

This paper explores the equity of the way losses from bank insolvencies and their avoidance through intervention by the authorities have been distributed over creditors, depositors, owners and the population at large in transition and emerging economies. It suggests a number of regulatory reforms that would alter the balance between seeking to avoid insolvency and lowering the costs of insolvency should it occur. It considers whether a lex specialis for dealing with problem banks by prompt corrective action and if necessary resolving them if their net worth falls to zero, at little or no cost to the taxpayer can be applied in the circumstances of transition and emerging economies.     

The regulatory response to the financial crisis

There are numerous aspects concerning financial regulation which the current financial turmoil has high-lighted. These include: (1) the form of deposit insurance; (2) bank solvency regimes, ‘prompt corrective action’; (3) Central Banks’ money market operations; (4) commercial bank liquidity risk management; (5) procyclicality of CARs (and mark-to-market); lack of counter-cyclical instruments; (5) boundaries of regulation, conduits, SIVs and reputational risk; (6) crisis management: (a) within countries, e.g. UK Tripartite Committee; or (b) cross-border, how to allocate the burden of cross-border defaults? This paper describes how the crisis exposed regulatory failings, drawing largely on UK experience, and suggests remedies.     

Financial Flexibility,Bank Capital Flows,and Asset Prices

In our parsimonious general‐equilibrium model of banking and asset pricing, intermediaries have the expertise to monitor and reallocate capital. We study financial development, intraeconomy capital flows, the size of the banking sector, the value of intermediation, expected market returns, and the risk of bank crashes. Asset pricing implications include: a market's dividend yield is related to its financial flexibility, and capital flows should be important in explaining expected returns and the risk of bank crashes. Our predictions are broadly consistent with the aggregate behavior of U.S. capital markets since 1950.     

CECL: Timely Loan Loss Provisioning and Bank Regulation

We investigate how provisioning models interact with bank regulation to affect banks' risk-taking behavior. We study an accuracy versus timeliness trade-off between an incurred loss model (IL) and an expected loss model (EL) such as current expected credit loss model or International Financial Reporting Standards 9. Relative to IL, even though EL improves efficiency by prompting earlier corrective action in bad times, it induces banks to originate either safer or riskier loans. Trading off ex post benefits versus ex ante real effects, we show that more timely information under EL enhances efficiency either when banks are insufficiently capitalized or when regulatory intervention is likely to be effective. Conversely, when banks are moderately capitalized and regulatory intervention is sufficiently costly, switching to EL impairs efficiency. From a policy perspective, our analysis highlights the roles that regulatory capital and the effectiveness of regulatory intervention play in determining the economic consequences of provisioning models. EL spurs credit supply and improves financial stability in economies where intervening in banks' operations is relatively frictionless and/or regulators can tailor regulatory capital to incorporate information about credit losses.     

An Analysis of European Banks' SND Issues and its Implications for the Design of a Mandatory Subordinated Debt Policy

During the last twenty years an increasing number of proposals to improve bank market discipline through the introduction of a mandatory subordinated debt policy (MSDP) have been presented and critically discussed by academic economists and bank regulators. While theoretical issues are key in this debate, a proper understanding of the market for banks' subordinated notes and debentures (SND) and the main features of securities is also considered relevant for the potential introduction, design and goals setting of such a policy. This paper builds on information concerning issuers, investors, markets, pricing and the technical features of securities to critically discuss these aspects. Data on over 1800 European banks SND issues completed during the 1988–2000:Q1 period together with information on primary and secondary market functioning are presented.     

Bank regulation,property prices and early warning systems for banking crises in OECD countries

Early warning systems (EWS) for banking crises generally omit bank capital, bank liquidity and property prices. Most work on EWS has been for global samples dominated by emerging market crises where time series data on bank capital adequacy and property prices are typically absent. We estimate logit crisis models for OECD countries, finding strong effects from capital adequacy and liquidity ratios as well as property prices, and can exclude traditional variables. Higher capital adequacy and liquidity ratios have a marked effect on the crisis probabilities, implying long-run benefits to offset some of the costs that such regulations may impose.     

Capital ratios and bank lending: A matched bank approach

This paper examines the impact of bank capital ratios on bank lending by comparing differences in loan growth to differences in capital ratios at sets of banks that are matched based on geographic area as well as size and various business characteristics. We argue that such comparisons are most effective at controlling for local loan demand and other environmental factors. For comparison we also control for local factors using MSA fixed effects. We find, based on data from 2001 to 2011, that the relationship between capital ratios and bank lending was significant during and shortly following the recent financial crisis but not at other times. We find that the relationship between capital ratios and loan growth is stronger for banks where loans are contracting than where loans are expanding. We also show that the elasticity of bank lending with respect to capital ratios is higher when capital ratios are relatively low, suggesting that the effect of capital ratio on bank lending is nonlinear. In addition, we present findings on the relationship between bank capital and lending by bank size and loan type.     

Why Capital Efficiency Measures Are Rarely Used in Incentive Plans, and How to Change That

Despite the wide acceptance of DCF valuation and its corollary that value is created only by earning more than the cost of capital, very few companies use performance measures that focus on corporate efficiency in using capital—measures such as return on capital (ROC) or economic value added (EVA)—as the main basis for their top management incentive programs. In this article, the authors begin by documenting the surprisingly limited use of such measures in management incentive plans. Next they analyze three often cited problems—difficulty in retaining managers, discouragement of growth investment, and complexity—that could account for the limited use of such measures. Third and last, they suggest a number of adjustments to standard capital efficiency measures that are designed to address these problems and, in so doing, to give corporate directors more confidence in using measures like EVA to reward and hold managers accountable for value-adding performance.
In illustrating the problems encountered when using such performance measures, the article uses case studies of three long-time "EVA companies"—Briggs & Stratton, Herman Miller, and Manitowoc—to highlight the difficulty of using a "bonus bank" (or "clawback") system to hold managers fully accountable for earning a minimum return on capital. After presenting empirical data that shows "delayed productivity" of invested capital, the authors suggest that conventional capital efficiency measures can discourage value-increasing growth.
The article concludes by recommending that although measures like EVA used in combination with negative bonus banks provide the right incentives, EVA capital charges should be phased in gradually to reflect the delayed productivity of capital. At the same time, corporate boards should consider providing bonus bank "relief" when market and industry factors have excessively large negative effects on the performance measures and bonus awards.     

Bank Portfolio Allocation: The Impact of Capital Requirements, Regulatory Monitoring, and Economic Conditions

This paper develops a structural, dynamic model of a banking firm to analyze how banks adjust their loan portfolios over time. In the model, banks experience capital shocks, face uncertain future loan demand, and incur costs based on their proximity to regulatory minimum capital requirements and the intensity of regulatory monitoring. Implications of the model then are estimated using panel data on large U.S. commercial banks operating continuously between December 1989 and December 1997. The estimated model is used to simulate the optimal bank response to (1) past and proposed changes in capital requirements, (2) changes in regulatory monitoring intensity, and (3) economic downturns. The simulation results are used to shed light on the decline in loan growth and the rise in bank capital ratios witnessed over a decade ago as well as the possible impact of the current proposed modification to capital requirements.