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Abstract Using the test of Granger-causality in tail of Hong et al. (2009), we define and construct Granger-causality tail risk networks between 33 systemically important banks (G-SIBs) and 36 sovereign bonds worldwide. Our purpose is to exploit the structure of the Granger-causality tail risk networks to identify periods of distress in financial markets and possible channels of systemic risk propagation. Combining measures of connectedness of these networks with the ratings of the sovereign bonds, we propose a flight-to-quality indicator to identify periods of turbulence in the market. Our measure clearly peaks at the onset of the European sovereign debt crisis, signaling the instability of the financial system. Finally, we use the connectedness measures of the networks to forecast the quality of sovereign bonds. We find that connectedness is a significant predictor of the cross-section of bond quality. [ABSTRACT FROM AUTHOR]

Abstract One of the most important elements of the post-crisis financial reforms was to establish credible resolution frameworks allowing for creditor bail-in when banks are entering resolution. Despite the obvious benefits of shifting the burden of resolution from taxpayers to bank creditors, bank bail-ins may also give rise to costs as the financial consequences for bank shareholders and creditors being bailed in could endanger their own financial situation and potentially entail systemic implications. Using granular data on the securities cross-holdings among the largest euro area banking groups, we construct a multi-layered network model where each layer represents bail-inable securities of a specific seniority layer of the creditor hierarchy. The model can be a useful tool for resolution authorities to inform the policy discussion on both the composition and level of loss absorbing capacity of banks and the direct contagion risk following a bail-in. We find that due to low levels of securities cross-holdings in the interbank network there is no direct contagion in terms of creditor banks failing as a result of another bank being bailed in. At the same time, we document that a bail-in will have pecuniary consequences on the different liability holders and our framework allows for an exact quantification of those effects. In addition, we show that recapitalisations following a bail-in will change the network structure and hence the embedded contagion risk. [ABSTRACT FROM AUTHOR]

This paper studies the effect of information disclosure on banks’ portfolio risk. We cast a simple banking system into a general equilibrium model with trading frictions. We find that the information disclosure lowers the expected risk-adjusted profits for a non-negligible fraction of banks. The magnitude of this effect depends on the structure of the banking system and, alarmingly, it is more pronounced for systemically important institutions. We connect these theoretical findings to the stress test procedure, where bank information is disclosed by the regulator. The 2011 and 2014 stress tests are used in an empirical study to further support our theoretical results. [ABSTRACT FROM AUTHOR]

Using data on publicly traded banks in 61 countries, we examine how the institutional environment affects the relationship between bank capital and system-wide fragility. Consistent with prior studies, we find that bank capital is associated with a reduction in the systemic risk contribution of individual banks. This effect is more pronounced for banks located in countries with less efficient public and private monitoring of financial institutions and in countries with lower levels of information availability. Overall, our findings suggest that capital can act as a substitute for a weak institutional environment in reducing systemic risk. [ABSTRACT FROM AUTHOR]

An extensive review of the evidence related to the 2007–09 crisis reveals that it was an insolvency risk crisis, not a liquidity crisis. The appropriate post-crisis regulatory reform should therefore focus on increasing capital requirements. The Basel III liquidity requirements do not serve a useful economic purpose in dealing with the root causes of the stresses that led to the 2007–09 crisis, and unnecessarily constrain the asset transformation and liquidity creation roles of banks to the detriment of economic growth. [ABSTRACT FROM AUTHOR]

We find that multi-bank holding companies (MBHCs) in the U.S. have lower insolvency risk than single-bank holding companies (SBHCs) at the parent level, but have significantly higher insolvency risk than the latter at the subsidiary level. Our results suggest that MBHC parents tend to benefit from the internal capital market while allowing for more risk-taking at the individual levels. We further find that the higher risk for MBHC affiliates is because of the organizational and geographic complexity at the MBHC parent level. Our results highlight the importance of government regulation on banks at both parent and subsidiary levels. [ABSTRACT FROM AUTHOR]

Previous work suggests that the charter value hypothesis is theoretically grounded and empirically supported, but not universally. Accordingly, this paper aims to perform an analysis of the relations between charter value, risk taking, and supervision, taking into account the relations’ complexity. Specifically, using the CAMELS rating system as a general framework for supervision, we study how charter value relates to risk and supervision by means of classification and regression tree analysis. The sample covers the period 2005–2016 and consists of listed banks in countries that were members of the Eurozone when it came into existence, along with Greece. To evaluate the crisis consequences, we also separately analyze four subperiods and countries that required financial aid from third parties and those that did not so, along with large and small banks. Our results reflect the complexity of the relations between charter value, supervision, and risk. Indeed, supervision and charter value seem aligned regarding only some types of risk. [ABSTRACT FROM AUTHOR]

We analyze the link between banking sector quality and sovereign risk in the whole European Union over 1999–2014. We employ four different indicators of sovereign risk (including market- and opinion-based assessments), a rich set of theoretically and empirically motivated banking sector characteristics, and a Bayesian inference in panel estimation as a methodology. We show that a higher proportion of non-performing loans is the single most influential sector-specific variable that is associated with increased sovereign risk. The sector’s depth provides mixed results. The stability (capital adequacy ratio) and size (TBA) of the industry are linked to lower sovereign risk in general. Foreign bank penetration and competition (a more diversified structure of the industry) are linked to lower sovereign risk. Our results also support the wake-up call hypothesis in that markets re-appraised a number of banking sector-related issues in the pricing of sovereign risk after the onset of the sovereign crisis in Europe. [ABSTRACT FROM AUTHOR]

We construct a measure of systemic vulnerability in selected EU banking systems using an indirect, time-varying measure of the system covariance. Systemic vulnerability indicates the extent to which a banking system as a whole is sensitive to a negative shock. We proceed to examine to what extent the resulting measures of systemic vulnerability provide a convincing narrative of events during the period January 2000 to April 2016. The results provide evidence of: (i) rising vulnerability prior to the outbreak of the international financial crisis in 2007/08 in countries with banks exposed to toxic assets; (ii) vulnerability associated with the euro area sovereign debt crisis from 2009/10; and (iii) continued concerns from 2013 onwards regarding the need for euro area banks to improve their balance sheets and raise new capital at a time of sluggish profitability. [ABSTRACT FROM AUTHOR]

This study presents a novel way to measure changes in commercial banks’ credit risk based on higher-order moments of the interest rate distribution. These measures are employed as control variables to investigate the pass-through of changes in the monetary policy rates (MPR) to retail banks’ lending rates to firms. Applying a multivariate framework it is shown that the introduced credit risk measures are statistically significant and have the expected signs. In this context, the pass-through is symmetric and complete in the short run. No evidence indicates that expectations of MPR changes matter for banks’ lending rates in Chile and robustness analyses indicate that neither do macroeconomic factors. The results suggest that credit risk should be taken into account when evaluating changes in banks’ lending rates and higher-order moments of the interest rate distribution are suitable for measuring changes in this risk. [ABSTRACT FROM AUTHOR]

We study a sample of the world’s largest financial conglomerates from 15 countries and we track their largest divestitures over the period 2005–2016. We develop a novel market-based metric to analyse the impact of divestitures on financial conglomerate excess value, and our findings point to divestitures having a significant impact on financial conglomerate valuation, contributing to a reduced conglomerate discount. Our results are driven by sales of financial service assets. Selling assets unrelated to the financial sector has no significant effect on conglomerate excess value. These results are robust with the inclusion of multiple control variables and alternative econometric model specifications. Altogether these results cast doubts on the existence of large benefits for financial conglomerates from combining financial service activities. This study has implications both for financial conglomerate boards who might direct their strategies to downsize their firms, and for regulators who address issues related to financial stability. [ABSTRACT FROM AUTHOR]

This paper analyzes the impact of geographic diversification on bank value by employing a data set comprising the largest banks across the world, originating from both developed and emerging countries. The findings suggest that the value impact of international diversification depends on a bank's home country: higher levels of diversification are associated with changes in valuations only for banks originating from emerging countries. In addition, the locus of destination of the diversification efforts matters for the direction of effects: while higher levels of intra-regional diversification lead to value enhancement, higher levels of inter-regional diversification seem to induce a negative (but statistically less robust) effect on the valuation of emerging country banks. [ABSTRACT FROM AUTHOR]

The level as well as fluency of capital supply on the interbank market is crucial for banking sector liquidity. However, the dominance of individual players on this market leads to liquidity imbalance and, thus, might increase the risk for other banks. We test how different bank exposures in interbank market translates into other bank liquidity risk and credit supply. To this end, we use 207 bank exits from interbank markets between 1997 and 2013 in 52 emerging and developed countries. We find that the withdrawal of a bank with high net exposure on interbank market leads to a statistically significant drop in the liquidity position of the remaining banks. The effect is also economically significant. Finally, we find that a liquidity imbalance adversely affects the bank credit supply. Our findings suggest that the consequences are more severe for banks heavily relying on the local interbank market, for emerging countries and surprisingly in pre-crisis periods. [ABSTRACT FROM AUTHOR]

This paper examines the financial market impact of intermeeting communication of the members of the European Central Bank’s Governing Council (GC) using high frequency data between July 2008 and January 2014. Constructing a rich dataset of GC members’ public statements (speeches, conference discussions and media interviews) between monetary policy meetings allows us to investigate a detailed pattern of market responses to the ad-hoc communication of central bankers. Using least squares and quantile regressions, we document the impact of policymakers’ public statements on interest rates and the stock market with very little or no impact on exchange rates. In general, we find little evidence that the timing, sequencing or content of communication matters in immediate response. On the contrary, the results suggest that the market concentrates on the communication of key members of the committee. [ABSTRACT FROM AUTHOR]

We consider the effectiveness of unit root exuberance tests in predicting banking crises. Using a sample of 15 EU countries over the past three decades, our crisis dating follows the scheme of the European Systemic Risk Board. The exuberance indicators slightly outperform benchmark signaling and logit models. Variables based on credit- and debt-service are identified as better predictors than housing market variables, which in turn outperform stock market variables. The results corroborate the existing literature, which says financial crises are typically preceded by leveraged bubbles, and more specifically, that initial bubble signals from explosive growth in credit and asset prices are followed by a lift-off in debt-servicing costs as a financial crisis nears. The risk of financial crisis peaks just after the bubble bursts. Our results indicate that exuberance tests, which can be used in crisis prediction in a manner similar to conventional early warning models, may be readily incorporated into the toolkit of financial stability supervisors. [ABSTRACT FROM AUTHOR]

Using a unique sample of mortgage loans for the UK buy-to-let market, we estimate a “double trigger” default model which links originating debt service and loan-to-value ratios to ex post default. We investigate whether the relationship between these ratios and default can be informative in the calibration of macro-prudential limits. We find default increasing with originating loan-to-value and falling in the origination debt service ratio. A non-linear cubic spline model is used to identify threshold effects and we identify clear turning points in these relationships. This analysis could provide one input into supervisory considerations when setting limits in a macro prudential context. In addition, we investigate how multiple loan portfolios interact with these thresholds with strong evidence to support tighter macroprudential restrictions on loans for second and subsequent properties. [ABSTRACT FROM AUTHOR]

Widespread bank losses during the financial crisis have raised concerns that equity-based compensation for bank CEOs causes excessive risk-taking. Debt-based compensation, so-called inside debt, aligns the interests of CEOs with those of external creditors. We examine whether inside debt induces CEOs to pursue less risky acquisitions. Consistent with this, we show that acquisitions announced by CEOs with high inside debt incentives are associated with a wealth transfer from equity to debt holders. After the completion of a deal, banks where acquiring CEOs have high inside debt incentives display lower market measures of risk and lower loss exposures for taxpayers. [ABSTRACT FROM AUTHOR]

We analyse the default behaviour of Spanish households immediately before and after the recent financial crisis. Using several waves of the Survey of Household Finances (a tri-annual survey of financial position of Spanish households), we show that younger, poorer and less well educated households are most likely to default. A key contribution is to explain the change in arrears since the onset of the crisis. Using information on credit applications and acceptances we decompose the change in arrears among all households into a contribution from four parts: (i) changes in characteristics; (ii) changes in applications; (iii) changes in acceptances; (iv) changes in arrears among borrowers. We show the last is the most important contribution. [ABSTRACT FROM AUTHOR]

I develop a theory of multiple maturity segments on the interbank market based on the persistence of liquidity shocks and banks’ liquidity management. The developed framework is embedded in a micro-founded network model, which features interbank funding as an over-the-counter phenomenon and replicates financial system phenomena of network formation, monetary policy transmission, and endogenous money creation. This setup is used to shed light on the interbank market's role for allocation and stability in the financial system. I show that the amount of interbank funding depends on the persistence and magnitude of liquidity shocks, as well as banks’ liquidity requirement. Optimal monetary policy experiments show that while interbank funding allows for considerably higher loan provision to the real economy, its term segment, by increasing the size of the interbank market, reduces that effect. Furthermore, the central bank's interest rate policy can effectively mitigate systemic risk and allow for higher sustainable loan supply of the real economy in regimes with lenient capital requirements. However, it is less effective in stimulating loan provision in more restrictive regulatory regimes. [ABSTRACT FROM AUTHOR]

We analyze the interaction among market competition, capital regulation, fixed regulatory compliance costs, and the portfolio and monitoring decisions of banks. We examine how the interplay among the effects of changes in the degree of competition and capital requirements regulation influence optimal bank choices and market outcomes. Furthermore, we evaluate how ratcheting up the Basel regulatory regime is likely to influence both the competitive structure of banking markets and the overall quality of bank loans. Higher capital requirements and increased fixed costs reduce the degree of competition in banking markets. The weight of these changes can fall more heavily on banks that choose to expend resources to monitor their loans to address loan losses. [ABSTRACT FROM AUTHOR]

This study investigates how the political connections of government bank CEOs affected their banks’ performance during the 2007–2009 financial crisis. Examination of global data shows that government banks with politically connected CEOs experienced significantly higher loan default rates and worse operating performance during the crisis than those without politically connected CEOs. However, these politically connected CEOs were less likely than others to be penalized for the poor performance of their banks. Our evidence suggests that politically connected CEOs of government banks can influence a bank’s lending decisions by using their political power and influence to relax lending standards and to reap private benefits that thus raise their banks’ sensitivity to a crisis. [ABSTRACT FROM AUTHOR]

Building on the literature on systemic risk and financial contagion, the paper introduces estimated network linkages into an early-warning model to predict bank distress among European banks. We use multivariate extreme value theory to estimate equity-based tail-dependence networks, whose links proxy for the markets’ view of bank interconnectedness in case of elevated financial stress. The paper finds that early warning models including estimated tail dependencies consistently outperform bank-specific benchmark models without networks. The results are robust to variation in model specification and also hold in relation to simpler benchmarks of contagion. Generally, this paper gives direct support for measures of interconnectedness in early-warning models, and moves toward a unified representation of cyclical and cross-sectional dimensions of systemic risk. [ABSTRACT FROM AUTHOR]

We examine the effect of ex-post information contagion on the ex-ante level of systemic risk defined as the probability of joint bank default. Because of counterparty risk or common exposures, bad news about one bank reveals valuable information about another bank, triggering information contagion. When banks are subject to common exposures, information contagion induces small adjustments to bank portfolios and therefore increases overall systemic risk. When banks are subject to counterparty risk, by contrast, information contagion induces a large shift toward more prudential portfolios, thereby reducing systemic risk. [ABSTRACT FROM AUTHOR]

Unsustainable credit developments lead to the build-up of systemic risks to financial stability. While this is an accepted truth, how to assess whether risks are getting out of hand remains a challenge. To identify excessive credit growth and aggregate leverage we propose an early warning system, which aims at predicting banking crises. In particular, we use a modern classification tree ensemble technique, the “Random Forest”, and include (global) credit as well as real estate variables as predictors. [ABSTRACT FROM AUTHOR]

Research on interbank networks and systemic importance is starting to recognise that the web of exposures linking banks’ balance sheets is more complex than the single-layer-of-exposure approach suggests. We use data on exposures between large European banks, broken down by both maturity and instrument type, to characterise the main features of the multiplex (or multi-layered) structure of the network of large European banks. Banks that are well connected or important in one network, tend to also be well connected in other networks (i.e. the network features positively correlated multiplexity). The different layers exhibit a high degree of similarity, stemming both from standard similarity analyses as well as a core-periphery analyses at the layer level. We propose measures of systemic importance that fit the case in which banks are connected through an arbitrary number of layers (be it by instrument, maturity or a combination of both). Such measures allow for a decomposition of the global systemic importance index for any bank into the contributions of each of the sub-networks, providing a potentially useful tool for banking regulators and supervisors in identifying tailored policy responses. We use the dataset of exposures between large European banks to illustrate that both the methodology and the specific level of network aggregation may matter both in the determination of interconnectedness and in the policy making process. [ABSTRACT FROM AUTHOR]

This article reviews empirical studies on Islamic banking and concentrates on their main findings while highlighting future research directions. The earlier literature on Islamic banking built a foundation using normative judgment, descriptive analysis, theoretical development, and appraisal of country experiences. The paper discusses scholars’ concerns that have led to a paradigm shift in the system and highlight practitioners’ disquiet about recent practices. Subsequent research focuses on empirical investigations without extensive analytical and theoretical exploration in the area. Recent studies focus on the financial crisis, solvency, maqasid , disclosure and financial inclusion, and regulations. Even with the spillover effect on the Islamic banks after the crisis, a few pieces of evidence show that the system performs below its conventional counterpart. The paper discusses issues that are relevant to Islamic banking and identifies other avenues for future research. [ABSTRACT FROM AUTHOR]

The implementation of tighter regulation and more powerful supervision may impose large social costs due to the strong reliance on supervisory information that requires direct assessment by a supervisor (i.e. Mandatory Supervision). We show that by introducing a Flexible Supervision contract, which is designed to be chosen by those banks that have incentives to capture the supervisor and allows them to bypass Mandatory Supervision, the most efficient regulation under asymmetric information may be implemented. Benevolent regulators should introduce Flexible Supervision regimes for the less risky, more capitalized and transparent banks in addition to the traditional Mandatory Supervision regime. [ABSTRACT FROM AUTHOR]

During the global financial crisis, a large number of banks worldwide either failed or received financial aid thus inflicting substantial losses on the system. We contribute to the early warning literature by constructing a dynamic competing risks hazard model that explores the joint determination of the probability of a distressed bank to face a licence withdrawal or to be bailed out. The underlying patterns of distress are analysed based on a broad range of bank-level and environmental factors. We find that institutions with inadequate capital, illiquid and risky assets, poor management, low levels of earnings and high sensitivity to market conditions have a higher probability to go bankrupt. Bailed out banks, on the other hand, face both capital and liquidity shortages, experience low earnings, and are highly exposed to market products; however, neither the managerial expertise, nor the quality of assets is relevant to the odds of bailout. We further document that large and complex banks are less likely to fail and more likely to be bailed out and also that authorities are more prone to provide support to a distressed bank, which is well-connected with politicians and political parties and less prone to let it go bankrupt. Importantly, our model outperforms the commonly used logit model in terms of forecasting power in all the in- and out-of-sample tests we conduct. [ABSTRACT FROM AUTHOR]

Syndication increases the overlap of bank loan portfolios and makes them more vulnerable to contagious effects. We develop a novel measure of bank interconnectedness using syndicated corporate loan portfolios, overlap based on industry and region, and different weights such as equal weights, size and relationships. We find that interconnectedness is driven mainly by bank diversification, less by bank size or overall loan market size. Interconnectedness is positively correlated with different bank-level systemic risk measures including SRISK, DIP and CoVaR, and such a positive correlation mainly arises from an elevated effect of interconnectedness on systemic risk during recessions. Overall, our results highlight that institution-level risk reduction through diversification ignores the negative externalities of an interconnected financial system. [ABSTRACT FROM AUTHOR]

Interbank funding markets are central to the functioning of the financial system and the transmission of monetary policy. Libor–OIS spreads have been widely-used indicators of conditions in these markets. We construct models that incorporate the long-run equilibrium relationship between term Libor and OIS rates and their regime-dependent dynamics. We find strong evidence for three regimes in the interbank funding market that resemble different pricing of risk and equilibrium outcomes. We provide point and interval estimates for stress thresholds that may serve as benchmarks for policy makers and market participants in assessing funding conditions. We provide evidence of asymmetric adjustment of rates toward long-run equilibrium, and shed light on the role of different policy measures in the adjustment process. [ABSTRACT FROM AUTHOR]

We measure systemic risk in the network of financial market infrastructures (FMIs) as the probability that two or more FMIs have a large credit risk exposure to a common FMI participant. We construct indicators of credit risk exposures in three main Canadian FMIs and use multivariate extreme value methods to estimate this probability. We find large differences in the levels of systemic risk across participants. Conditional on the participant being distressed, we re-estimate these probabilities and find that some participants create large exposures to FMIs, resulting in a larger level of systemic risk than the rest of the participants. Our results suggest that an appropriate oversight of FMIs may benefit from an in-depth system-wide analysis, which may have useful implications for the macroprudential regulation of the financial system. [ABSTRACT FROM AUTHOR]

There is a current controversy concerning the appropriate size of banks’ capital requirements, and the trade-off between the costs and benefits of implementing higher capital requirements. We quantify the size of capital buffers required to reduce system-wide losses using confidential regulatory data for Australian banks from 2002 to 2014 and annual public accounts from 1978 to 2014. We find that a moderate increase in bank capital buffers is sufficient to maintain financial system resilience, even after taking economic downturns into consideration. Furthermore, while banks benefit from paying a lower cost of debt when they have a higher capital buffer, lending volumes are lower indicating that credit supply may be hampered if bank capital levels are too high within a financial system. [ABSTRACT FROM AUTHOR]

The paper constructs an overlapping generations model to evaluate how different bank rescue plans affect banks’ risk-taking incentives. For a non-competitive banking industry, we find bailout with tax imposed on the old generation or equity bail-in to be efficient policies in the sense that they implement socially optimal risk-taking. In a competitive banking sector, no-bailout implements the socially-optimal risk-taking. Bailout policies financed by a tax imposed on the young generation always induce excessive risk-taking. [ABSTRACT FROM AUTHOR]

This paper investigates how banking system stability is affected when we combine Islamic and conventional finance under the same roof. We compare systemic resilience of three types of banks in six GCC member countries with dual banking systems: fully-fledged Islamic banks (IB), purely conventional banks (CB) and conventional banks with Islamic windows (CBw). We employ market-based systemic risk measures such as MES, SRISK and CoVaR to identify which sector is more vulnerable to a systemic event. We also compute weighted average GES to determine which sector is most synchronised with the market. Moreover, we use graphical network models to determine the most interconnected banking sector that can more easily spread a systemic shock to the whole system. Using a sample of observations on 79 publicly traded banks operating over the 2005–2014 period, we find that CBw is the least resilient sector to a systemic event, it has the highest synchronicity with the market, and it is the most interconnected banking sector during crisis times. [ABSTRACT FROM AUTHOR]

A mortgage that defaults is more likely to enter foreclosure rather than renegotiation if it has been securitized in the private non-agency market, according to previous research. We study whether this foreclosure-propensity affects lenders’ securitization decision ex-ante. Due to the higher foreclosure probability, the value of a mortgage should be more sensitive to foreclosure costs if it is securitized. Comparing loans made in the same metropolitan area but under different foreclosure laws, we find that lenders are less likely to securitize mortgages in states with higher foreclosure costs, as measured by laws requiring judicial foreclosure. Two additional results are consistent with the proposed channel. First, the effect increases for loans with higher expected default rates and disappears for mortgage-like loans not subject to these laws. Second, the effect of judicial requirements increases for loans with higher expected default rates, consistent with differences in loss given default driving the results. Borrowers in states without judicial requirements also get riskier loans. [ABSTRACT FROM AUTHOR]

Using a sample of public and private banks, we study how social capital relates to bank stability. Social capital, which reflects the level of cooperative norms in society, is likely to reduce opportunistic behavior (Jha and Chen 2015; Hasan et al., 2017) and, therefore, act as an informal monitoring mechanism. Consistent with our expectations, we find that banks in high social capital regions experienced fewer failures and less financial trouble during the 2007–2010 financial crisis than banks in low social capital regions. In addition, we find that social capital was negatively associated with abnormal risk-taking and positively associated with accounting transparency and accounting conservatism in the pre-crisis period of 2000–2006, indicating that risk-taking, accounting transparency, and accounting conservatism are possible channels through which social capital affected bank stability during the crisis. [ABSTRACT FROM AUTHOR]

It is common in the supervision of banks to perform and disclose a simultaneous standardized assessment of their asset quality, organizational effectiveness, strategic viability and resilience to financial turmoil. By investigating the European Central Bank 2014 Comprehensive Assessment and the stock reactions of the banks to its findings, we find that this process provides limited assistance to the market in sorting good from troubled banks. Notwithstanding, the market adjusts to these findings, since it understands that they signal the stance of supervisory policy toward banking activities, which begets the level of regulatory risk and cost for the supervised banks. [ABSTRACT FROM AUTHOR]

We examine the impact of the financial crisis on the stock market valuation of large and systemic U.S. bank holding companies (BHCs). Using the Bertsatos and Sakellaris (2016) model of fundamental valuation of bank equity, we provide evidence that the financial crisis has not altered investors’ attitudes towards bank characteristics. In particular, before, during, and after the crisis, investors in large and systemic U.S. BHCs seemed to penalize leverage, albeit temporarily. Both before and after the crisis, they reward size in the short run. This pattern is appearing only briefly during the crisis. We also show that bank opacity plays no role in market valuation either in the short run or in the long run. Last but not least, we find evidence that stress testing has been informative to the market and that those BHCs that failed at the post-crisis stress tests were not subsequently valued differently by the market. [ABSTRACT FROM AUTHOR]

We examine the effects of bank’s political connection on bank performance and risk in China. We use hand-collected information on CEOs’ professional background to identify their political affiliations, and find that banks whose CEOs have former government experiences have higher return on assets, lower default risk, and lower credit risk. Additionally, politically connected banks have disproportionally higher performance when the CEOs previous worked in the same city where the current bank’s headquarter locates, had past banking experiences, spend more on entertainment and travel costs, and have higher previous administrative rankings (e.g., at the provincial or state level). These results suggest that politically connected banks have better access to lending to politically connected firms, which are high yield assets and more likely to be bailed out when in distress. Our results offer a mechanism of political rent seeking, consistent with the institutional environment of China’s banking and political system. [ABSTRACT FROM AUTHOR]

This paper exploits the Financial Accounts of the United States to derive long time series of bank and nonbank credit to different sectors, and to examine the cyclical behavior of these series in relation to (i) the long-term business cycle, (ii) recessions and recoveries, and (iii) systemic financial crises. We find that bank and nonbank credit exhibit different dynamics throughout the business cycle. We also examine the role of bank and nonbank credit in the creation of financial interconnections and illustrate a method to conduct macro-financial stability assessments. [ABSTRACT FROM AUTHOR]

In this paper we show in a thought experiment that in an economy where i) investors hold rational expectations, ii) output is generated by a linear homogeneous production function, and iii) real investment is allocated across sectors according to the CAPM, a fractional reserve banking system is not Pareto efficient and amplifies the business cycle. In developing these results we show that these three well known propositions in economics also imply a new view of the business cycle, one where the business cycle is described in terms of the dispersion of an ex-ante probability distribution. The policy implication of this analysis is that bank regulation should go further than the Volcker rule or the Vickers commission proposal by restricting bank investments to currency and deposit accounts on the central bank. Nonbank financial institutions should then carry out the financial intermediation function now carried out by banks. The paper proposes that post office banking perhaps augmented with blockchain technology sometime in the future is one way to implement the transition from fractional reserve banking to full reserve banking. While little academic work has been done on full reserve banking in the aftermath of the Great Crisis, it is interesting to note that it is part of banking reform proposals now (July 2016) before the parliament in Iceland and a special national referendum in Switzerland. [ABSTRACT FROM AUTHOR]

We investigate whether and how political systems affect the financial soundness of conventional and Islamic banks. Using factors extracted from principal component analysis, we find that Islamic banks underperform their conventional counterparts in more democratic political systems but outperform them in hybrid and Sharia’a -based legal systems. The findings reflect the challenges Islamic banks face in Western countries in terms of perception, financial infrastructure, and regulatory constraints while mirroring the recognition of their specificities and their cultural and religious compliance with Sharia’a law in Muslim countries. The findings are robust to a battery of alternative estimation techniques and methods of correcting standard errors. [ABSTRACT FROM AUTHOR]

The Term Auction Facility (TAF) was designed by the Federal Reserve during the financial crisis to inject emergency short-term funds into banks, as a supplement to the lender of last resort discount window offerings. We describe how the Federal Reserve altered the design of the Term Auction Facility (TAF) over the course of the financial crisis and examine the utilization of this stand-alone facility. Most specifically we detail the impact of the greatly increased offering amounts in all auctions after October 2008, which resulted in the facility no longer auctioning scarcely available funds. We also document significantly different usage of the facility by FDIC-insured community and non-community banks, consistent with the notion of a two-tiered banking system in the U.S. Community banks were far less likely to use the facility than larger, non-community banks. [ABSTRACT FROM AUTHOR]

We investigate whether foreign bank penetration affects the risk of domestic banks in emerging economies. By using bank-level data from 35 markets during the period of 2000–2014, we find significant evidence that the risk of domestic banks increases with the presence of foreign banks in the host economy, and this finding is shown to be consistent in a series of robustness tests. We also find that the incidence of such effects is more pronounced for domestic banks which are less efficient and less based on traditional activities. Foreign banks exert more pronounced impacts on domestic banks’ risk when they enter the host market via M&A, as opposed to greenfield investments, and when they belong to foreign conglomerates which provide strong internal support. [ABSTRACT FROM AUTHOR]

In this paper, we address the question of whether the gender of a firm’s leader affects the cost of bank funding faced by small and medium enterprises in Europe. Using a large sample of observations of non-financial firms, during the years 2009–2013, we empirically test for the presence of discrimination, comparing female-led and male-led firms. After controlling for a rich set of variables and addressing potential endogeneity, our results show that i ) female-led enterprises are more likely to face worse price conditions for bank financing compared to their male-led counterparts and, ii ) firms whose leadership changes from female to male are more likely to benefit from an improvement in interest rate levels. This evidence is robust to different model specifications and various methodological approaches. The existence of such bias in the credit markets highlights the need of policy measures addressing female-led businesses, thus reducing their bank financing burdens and enhancing their entrepreneurial opportunities. [ABSTRACT FROM AUTHOR]

This paper contributes to prior literature and to the current debate concerning recent revisions of the regulatory approach to measuring bank exposure to interest rate risk in the banking book by focusing on assessment of the appropriate amount of capital banks should set aside against this specific risk. We first discuss how banks might develop internal measurement systems to model changes in interest rates and measure their exposure to interest rate risk that are more refined and effective than are regulatory methodologies. We then develop a backtesting framework to test the consistency of methodology results with actual bank risk exposure. Using a representative sample of Italian banks between 2006 and 2013, our empirical analysis supports the need to improve the standardized shock currently enforced by the Basel Committee on Banking Supervision. It also provides useful insights for properly measuring the amount of capital to cover interest rate risk that is sufficient to ensure both financial system functioning and banking stability. [ABSTRACT FROM AUTHOR]

We employ a unique framework to quantify the net effect of financial liberalization on banks’ total factor productivity (TFP) growth through a decomposition analysis of two effects: a positive direct effect of financial liberalization on bank TFP growth; and a negative indirect effect operating through a higher propensity to systemic banking crisis. The empirical decomposition is based on a sample of 1530 banks operating in 88 countries over the period 1999–2011. We find that the net effect of financial liberalization on bank TFP growth is positive: the direct positive effect outweighs the negative one. An important policy implication flows from these findings. [ABSTRACT FROM AUTHOR]

In January 2006, federal regulators issued guidance requiring banks with specific high concentrations of commercial real estate (CRE) loans to tighten managerial controls. This paper shows that banks with concentrations in excess of the thresholds set in the guidance subsequently experienced slower growth in their CRE portfolios than can be explained by changes in bank or economic conditions. Moreover, banks above the CRE thresholds tended to have slower commercial and industrial loan growth but faster household loan growth following issuance of the guidance. The results highlight the potentially broad influence that portfolio-based macroprudential regulation might have on bank behavior. [ABSTRACT FROM AUTHOR]

We develop an empirically based simulation study to test two types of policies designed to control systemic risk: preventive policies targeting capital requirements and mitigation policies targeting default resolution. We find that capital buffers reduce both the number of defaults and the resulting losses. The loss reduction benefit increases as the magnitude of adverse shocks becomes higher. We find that a simple branch-breakup resolution strategy reduces the loss borne by the Federal Deposit Insurance Corporation (FDIC). The mitigation effect becomes higher as the fraction of assets resolved through auctions and auction competitiveness increase. [ABSTRACT FROM AUTHOR]

This paper examines the interplay among bank liquidity creation (which incorporates all bank on- and off-balance sheet activities), monetary policy, and financial crises. We find that: (1) high liquidity creation (relative to trend) – particularly off-balance sheet liquidity creation – helps predict crises, controlling for other factors; (2) monetary policy has statistically significant, but economically minor effects on liquidity creation by small banks during normal times, and these effects are even weaker during financial crises; (3) monetary policy has very little effects on medium and large bank liquidity creation during both normal times and crises. These findings suggest that authorities may wish to monitor bank liquidity creation closely in order to predict and perhaps lessen the likelihood of financial crises. They might also consider other tools to control bank liquidity creation, such as capital and liquidity requirements. [ABSTRACT FROM AUTHOR]