Bank Exposure to Interest Rate Risks During Financial Liberalization: Evidence from South Korea

This study documents the changing impact of long and short term interest rate risks on the equity prices of banks in South Korea during the process of financial liberalization. Consistent with the presence of regulatory constraints, Korean bank equity returns are found to be sensitive to both anticipated and unanticipated changes in interest rates in the first period (1976-81) when banks were largely under government control. However, during our last period (1989-99) of liberalization, Korean bank equity returns were found to have a positive association only with unanticipated short-term interest rates. Consistent with the ability to manage other interest rate risks successfully, in this last liberalization period, Korean bank equity returns had no association with long-term or with anticipated short-term interest rates. In view of the continued interest in banking and financial market liberalization among many Asian, African, and formerly socialist countries including China, these results should be of much banking and policy interest. JEL Classifications: G21, G28, E44, L89     

Banks’ equity performance and the term structure of interest rates

Using an extensive global sample, this paper investigates the impact of the term structure of interest rates on bank equity returns. Decomposing the yield curve to its three constituents (level, slope and curvature), the paper evaluates the time‐varying sensitivity of the bank's equity returns to these constituents by using a diagonal dynamic conditional correlation multivariate GARCH framework. Evidence reveals that the empirical proxies for the three factors explain the variations in equity returns above and beyond the market‐wide effect. More specifically, shocks to the long‐term (level) and short‐term (slope) factors have a statistically significant impact on equity returns, while those on the medium‐term (curvature) factor are less clear‐cut. Bank size plays an important role in the sense that exposures are higher for SIFIs and large banks compared to medium and small banks. Moreover, banks exhibit greater sensitivities to all risk factors during the crisis and post‐crisis periods compared to the pre‐crisis period; though these sensitivities do not differ for market‐oriented and bank‐oriented financial systems.     

What explains the lack of monetary policy influence on bank holding companies?

In this paper, we investigate how monetary policy innovations affect the equity returns of bank holding companies (BHCs). We also examine bank characteristics to determine what explains the cross-sectional and time-series variation in the returns' sensitivity. Similar to non-financial firms, we find that only unanticipated components affect bank equity returns; however, this effect is absent in the second half of our sample period. Smaller, less liquid banks have higher sensitivity; a higher ratio of time deposits to total deposits reduces this sensitivity. A higher ratio of non-interest income to total income also reduces this sensitivity, while capital-constrained banks have a higher sensitivity to monetary policy innovations. We argue that a higher dependence on non-interest income and the use of interest rate derivatives together may explain the disappearing influence of monetary policy on these BHCs.     

Delayed Expected Loss Recognition and the Risk Profile of Banks

This paper investigates the extent to which delayed expected loan loss recognition (DELR) is associated with greater vulnerability of banks to three distinct dimensions of risk: (1) stock market liquidity risk, (2) downside tail risk of individual banks, and (3) codependence of downside tail risk among banks. We hypothesize that DELR increases vulnerability to downside risk by creating expected loss overhangs that threaten future capital adequacy and by degrading bank transparency, which increases financing frictions and opportunities for risk‐shifting. We find that DELR is associated with higher correlations between bank‐level illiquidity and both aggregate banking sector illiquidity and market returns (i.e., higher liquidity risks) during recessions, suggesting that high DELR banks as a group may simultaneously face elevated financing frictions and enhanced opportunities for risk‐shifting behavior in crisis periods. With respect to downside risk, we find that during recessions DELR is associated with significantly higher risk of individual banks suffering severe drops in their equity values, where this association is magnified for banks with low capital levels. Consistent with increased systemic risk, we find that DELR is associated with significantly higher codependence between downside risk of individual banks and downside risk of the banking sector. We theorize that downside risk vulnerability at the individual bank level can translate into systemic risk by virtue of DELR creating a common source of risk vulnerability across high DELR banks simultaneously, which leads to risk codependence among banks and systemic effects from banks acting as part of a herd.     

The effects of a shift in monetary policy regime on the profitability and risk of commercial banks

This paper examines the effects of the Fed's October 6th, 1979 change in monetary policy regime on the profitability and risk of commercial banks. Using capital market data and an event study methodology it was found that bank stocks exhibited significant abnormal returns during the announcement week of the policy change. When these abnormal returns were decomposed into a part related to unexpected interest rate changes and a part (assumed) to reflect increased rate variability, the results were consistent with a negative relationship between bank returns and interest rate surprises as well as between bank returns and rate variability.     

The effects of shifts in monetary policy and reserve accounting regimes on bank reserve management behavior in the federal funds market

This paper looks at the effects on Fed fund rates and Fed fund purchasing behavior of large banks resulting from (i) the 1982 regime switch from non-borrowed to borrowed reserve targeting by the Fed and (ii) the 1984 switch from lagged to almost contemporaneous reserve accounting (CRA). Whether we analyse changes in the interest-rate or quantity dimensions, the shift in monetary policy targets appeared to have had a more profound effect on the market for bank reserves than the shift in reserve accounting regime. These results, therefore, tend to support the contention that a shift to CRA by itself will have little effect on bank reserve management behavior unless combined with its logical counterpart — a total reserves target.     

Sources of Bank Interest Rate Risk

We investigate bank stocks'sensitivity to changes in interest rates and the factors affecting this sensitivity. We focus on whether the exposure of commercial banks to interest rate risk is conditioned on certain balance sheet and income statement ratios. We find a significantly negative relation between bank stock returns and changes in interest rates over the period 1991–1996. We also find that bank characteristics measured from basic financial statement information explain bank stocks'sensitivity to interest rate changes. These results suggest that bank managers, analysts, and regulators can use this information to assess the relative risk exposure of banks.     

Are Investment Banks Special Too? Evidence on Relationship‐Specific Capital in Investment Bank Services

The question of whether optimal provision of these services comes mainly from established relationships between banks and client firms or can result from arms'‐length market transactions has been the topic of considerable recent debate. This discussion has paralleled the debate in the commercial banking literature on the “specialness” of banks and whether lending can and should be relational or purely transactional. Whether the provision of investment bank services is relationship‐based or transactional is especially relevant now thanks to recent trends that have blurred the distinction between commercial and investment banks, and changed the competitive landscape for investment bank services. In their study summarized in this article, the authors examine whether investment bank‐client relationships create valuable relationship‐specific capital using stock market evidence from the period surrounding the collapse of Lehman Brothers. Specifically, they studied the effect of the Lehman collapse on companies that used Lehman for (1) underwriting equity offerings, (2) underwriting debt offerings, (3) advice on mergers and acquisitions, (4) analyst research services, and (5) market‐making services. The study addressed two specific questions. First, which investment bank services, if any, are associated with the creation of relationship‐specific capital; and second, what are the value drivers of this relationship capital? The authors report finding that companies that used Lehman as lead underwriter for public equity offerings experienced significantly negative abnormal stock returns in the days surrounding Lehman's bankruptcy announcement. By contrast, they find no significant reaction to the announcement for Lehman's debt underwriting clients or any of the other client categories they examine. While most of these investment bank services have at least the potential to create relationship‐specific capital, the authors' findings suggest that except for equity underwriting, all the other investment bank services appear to be transactional rather than relationship‐based, at least in the average case. Moreover, the authors report significant differences even among different groups of Lehman's equity underwriting clients. An equity underwriting relationship with Lehman appears to have been especially valuable for smaller, younger, and more financially constrained firms—those firms which presumably had a high degree of dependence on Lehman to access the capital market.     

EFFECT OF FED POLICY ACTIONS ON THE DEFAULT LIKELIHOOD OF COMMERCIAL BANKS

Using a measure of default likelihood based on an option pricing method, we provide evidence that Fed policy actions affect the financial distress of commercial banks. When the Fed increases (decreases) interest rates, the measure of default likelihood increases (decreases). We show that when the Fed uses a tight money policy, the increase in default likelihood is more pronounced for banks that have less capital, have greater financial leverage, are smaller, have fewer growth opportunities, and have lower asset quality. Additionally, the effects on bank default likelihood are more pronounced when the Fed's policy signals less concern about economic growth, as indicated by its bias toward further tightening, and when there is a market expectation of higher short‐term market rates in the future.     

我国上市银行利差决定因素分析

本文对国内2000～2009年间上市银行利差率的决定因素按照银行经营的安全、效率和盈利指标,结合行业和宏观经济状况等因素进行了实证分析。结论表明,虽然股份制上市银行经营状况普遍优于国有银行,但其经营行为可能会部分抵消央行的利率政策,同时股票市场发展对银行经营没有显著性影响。     

Clawbacks and Cronyism: Evidence from China

This paper is the first to examine the long‐term impact on bank lending policy of clawbacks in executive compensation contracts. Using a hand‐gathered database of Chinese business lending, we find evidence of reduced cronyism at the Big Four Chinese banks during the period after the introduction of a clawback program, marking a shift from earlier studies covering earlier time periods that find evidence of widespread cronyism at the Big Four banks. Politically connected borrowers received fewer and smaller loans relative to non‐Big Four banks, consistent with a backlash against cronyism at the Big Four banks. In contrast, we find that cronyism persisted (i.e., politically connected borrowers received more and larger loans) at non‐Big Four Chinese banks where the clawback policy was not effective.     

宏观审慎政策工具的有效性检验——基于对114家商业银行的实证分析

本文基于国际货币基金组织调查数据库构建中国宏观审慎政策工具综合指标,同时选取存款准备金率和贷款价值比上限代表宏观审慎政策工具,检验宏观审慎政策工具的有效性.通过对2008—2018年间我国114家商业银行的实证检验发现,无论是单一宏观审慎政策工具,还是宏观审慎工具综合指标,均能抑制信贷规模以及房价的快速增长,减少系统性风险的积累;且针对特定目标设立的宏观审慎政策工具的政策效果更为显著.进一步研究发现,宏观审慎政策工具在微观层面也能有效抑制银行风险.就具体的政策效果而言,相较于国有银行和股份制银行,规模较小的城商行和农商行对宏观审慎政策工具的反应更为敏感.     

STATE DEPENDENCY OF BANK STOCK REACTION TO FEDERAL FUNDS RATE TARGET CHANGES

We investigate the effects of changes in the federal funds target rate on bank stock returns through an event‐study analysis. We examine the state dependency of such effects and focus on the surprise elements of policy changes derived from the federal funds futures market. Although we confirm an inverse relation between bank stock returns and changes in the federal funds target rate previously supported in the literature, we find that bank stock returns only respond to surprise or unexpected changes in the federal funds target rate. We also find that such responses are conditional on the context in which policy changes take place.     

Bank Capital: Lessons from the Financial Crisis

Using a multicountry panel of banks, we study whether better capitalized banks experienced higher stock returns during the financial crisis. We differentiate among various types of capital ratios: the Basel risk‐adjusted ratio, the leverage ratio, the Tier 1 and Tier 2 ratios, and the tangible equity ratio. We find several results: (i) before the crisis, differences in capital did not have much impact on stock returns; (ii) during the crisis, a stronger capital position was associated with better stock market performance, most markedly for larger banks; (iii) the relationship between stock returns and capital is stronger when capital is measured by the leverage ratio rather than the risk‐adjusted capital ratio; (iv) higher quality forms of capital, such as Tier 1 capital and tangible common equity, were more relevant.     

A Conditional Assessment of the Relationships between the Major World Bond Markets

This paper uses a bivariate GARCH framework to examine the lead‐lag relations and the conditional correlations between 10‐year US government bond returns and their counterparts from the UK, Germany, and Japan. We find that while mean and volatility spillovers exist between the major international bond markets, they are much weaker than those between equity markets. The results also indicate that the correlations between the US and other major bond market returns are time varying and are driven by changing macroeconomic and market conditions. However, in contrast to the finding that the benefits of international diversification in equity markets evaporate during high‐stress periods, we find that the benefits of diversification across major government bond markets do not decrease during periods of extremely high bond market volatility or following extremely negative US and foreign bond returns.     

The Impact of Trust-Preferred Issuance on Bank Default Risk and Cash Flow: Evidence from the Debt and Equity Securities Markets

Trust‐preferred stock is a debt‐equity hybrid that offers the tax deductibility of dividends but is treated as equity capital by bank regulators and rating agencies. The purpose of this paper is to examine whether holders of bank debt securities benefit from trust‐preferred issuance in the form of lower default premia and whether bank shareholders benefit from the tax deductibility of trust‐preferred dividends. Using daily returns surrounding the Federal Reserve's announcement that trust‐preferred securities would be included as a component of commercial banks' Tier I equity capital, we find evidence to support both hypotheses.     

Supply of bank loans and business debts: A view from historical bankruptcy cases

As bank loans fell in the 2008 crisis, business bankruptcy increased. To study how bank loans affect business balance sheets and bankruptcy, we use new data on bankrupt businesses in Missouri between 1898 and 1942. We confirm that when banks curtail loans, courts see more bankruptcies among businesses with high exposure to bank debt. To reduce real volatility, policy‐makers can set tough bank liquidity requirements in the upswing of business cycle but allow weaker requirements in the downswing. We also find that between 1914 and 1933, businesses in St. Louis were more sensitive to changes in bank loans than businesses in Kansas City, probably due to the tight monetary policy conducted by the conservative St. Louis Fed. The Glass‐Steagall Act weakened the relationship between bank loans and business debt structure. The takeaway is that lender‐of‐last‐resort practices stabilize both the financial sector and the real economy.     

ANALYSIS OF FEDERAL FUNDS RATE CHANGES AND VARIANCE PATTERNS

We analyze Fed funds rate changes in GARCH‐in‐mean (GARCH‐M) models and find that daily rate change and variance patterns differ with the timing of the rate observation, but that all patterns are generally consistent with optimal reserve account management. We also find that Fed funds daily and intraday variances exhibit trends and persistence, and that daily variance effects differ when using marginal rates versus daily weighted average rates. Furthermore, we find that conditional variances do not provide information about daily or intraday rate changes. Our results provide support for the use of GARCH models for studies on other financial assets. JEL classification: G21, G28     

Size Anomalies in U.S. Bank Stock Returns

The largest commercial bank stocks, ranked by total size of the balance sheet, have significantly lower risk‐adjusted returns than small‐ and medium‐sized bank stocks, even though large banks are significantly more levered. We uncover a size factor in the component of bank returns that is orthogonal to the standard risk factors, including small minus big, which has the right covariance with bank returns to explain the average risk‐adjusted returns. This factor measures size‐dependent exposure to bank‐specific tail risk. These findings are consistent with government guarantees that protect shareholders of large banks, but not small banks, in disaster states.